Mebe - Fii.eco Sem2

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Foreign Institutional Investments

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macroeconomicbusinessenvironment
















MACRO ECONOMIC

BUSINESS

ENVIRONMENT

FOREIGN INSTITUTIONAL

INVESTMENTS

(TERM PROJECT)

COMPILED BY:

Richa Sharma, Seat No. - 06

Shilpa Jacob P., Seat No. - 21

Deepam Jain, Seat No. - 29

Mannika Agarwal, Seat No. - 34

Rohan Roy, Seat No. - 37

Anil K Pathak, Seat No. - 73

Section – K,

ICFAI Business School,

SUBMITTED TO:

Prof. Binilkumar Amarayil

Sreeraman,

ICFAI Business School,

Hyderabad.




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Table of Contents

1. INTRODUCTION .................................................................................................................... 3

1.1. Foreign direct investment............................................................................................ 3

1.2. Foreign institutional investment................................................................................... 4

1.3. Benefits of FII in India................................................................................................ 5

2. ENTRY OPTIONS FOR FII IN INDIA .............................................................................. 6

2.1. Normal FIIs ............................................................................................................... 6

2.1.1. Preferential Allotment of Shares .......................................................................... 6

2.1.2. Qualified Institutions Placements (QIPs) .............................................................. 8

2.1.3. FCCB ................................................................................................................ 9

2.1.4. INITIAL PUBLIC OFFERING............................................................................ 9

2.2. 100% Debt FIIs........................................................................................................ 10

2.2.1. As FIIs............................................................................................................. 10

2.2.2. As Sub-accounts ............................................................................................... 13

2.2.3. Domestic entity................................................................................................. 13

2.2.4. PARTICIPATORY NOTES.............................................................................. 13

3. REGULATIONS IMPOSED BY INDIAN GOVERNMENT ON FII.................................. 15

4. REASONS FOR THE ATTRACTIVENESS OF INDIAN ECONOMY FOR FII ................ 17

5. EFFECT OF FII ON INDIAN MONETARY POLICY ...................................................... 19

5.1. Appreciation of The Currency................................................................................... 19

5.2. Depreciation of the Currency .................................................................................... 20

5.3. FII and exports ......................................................................................................... 20

5.4. FII and stock market................................................................................................. 21

5.5. FII and inflation ....................................................................................................... 21

5.6. FII and local companies ............................................................................................ 22

5.7. Capital formation in domestic market ........................................................................ 22

5.8. FII and the Hot Money Concept ................................................................................ 22

6. IMPACT OF FII ON THE FISCAL POLICY OF INDIA ................................................... 24

7. FIIS AND THE INDIAN STOCK MARKET.................................................................... 25

8. FOREIGN INVESTMENT FLOWS IN INDIA................................................................. 26

9. TRENDS IN FII INVESTMENT IN INDIA...................................................................... 29

10. BIBLIOGRAPHY........................................................................................................ 31




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1. INTRODUCTION

Foreign investment refers to investments made by the nationalist of a country in the financial

assets and production processes or directly in the stock market of another country. After the

opening up of the borders for capital movement, these investments have grown in number at a

exponential rate. The effect of foreign investment, however, varies from country to country

on the bases of both economical and political factors affecting that country. It can affect the

factor productivity of the recipient country and can also affect the balance of payments. In

developing countries like India which is the second fastest growing, there has been a great

need for foreign capital, not only to increase the productivity of labor but also because

foreign capital helps to build up the foreign exchange reserves needed to meet trade deficits

which is export minus imports. Foreign investment provides a channel through which

developing countries can gain access to foreign capital.

It can come in two forms:

Foreign direct investments(FDI)

Foreign institutional investment (FII).

1.1.Foreign direct investment:- It involves in direct production activities and is also of a

medium- to long-term nature. Foreign direct investment (FDI) or foreign investment

refers to long term participation by a country into another country. It usually involves

participation in management, joint-venture, transfer of technology and expertise. India

has been ranked at the third place in global foreign direct investments in 2009 and will

continue to remain among the top five attractive destinations for international investors

during 2010-11. Foreign direct business relationships give rise to multinational

corporations. For an investment to be regarded as an FDI, the parent firm needs to have at

least 10% of the ordinary shares of its foreign affiliates. The investing firm may also

qualify for an FDI if it owns voting power in a business enterprise operating in a foreign

country. DIs can be broadly classified into two types: outward FDIs and inward FDIs.

This classification is based on the types of restrictions imposed, and the various

prerequisites required for these investments.




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1.2.Foreign institutional investment is a short-term investment, mostly in the financial

markets. FII, given its short-term nature, can have 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. This project examines the determinants of foreign inst itutional

investment in India, a country that opened its economy to foreign capital. India has taken

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

to the end of January 2003, India succeeded in attracting a total foreign investment of

around U.S.$48 billion out of which U.S.$12 billion was in the form of FII. India is in the

process of liberalizing its capital account, and this has a significant impact on foreign

investment and particularly on FII, which affects short-term stability in the financial

markets.




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1.3.Benefits of FII in India:-

Imparting stability to India's Balance of Payments

For promoting growth in a developing country such as India, there is need to augment

domestic investment, over and beyond domestic saving, through capital flows. Theexcess of domestic investment over domestic savings result in a current account

deficit and this deficit is financed by capital flows in the balance of payments.

Knowledge flows

The actions of foreign institutional investors help strengthen Indian finance. FIIs

Embedded modern ideas in market design, promote innovation, development of

sophisticated products such as financial derivatives, enhance competition in financial

intermediation.

Strengthening corporate governance

FIIs, with their vast experience with modern corporate governance practices, are less

tolerant of malpractice by corporate managers and owners (dominant shareholder). FII

participation in domestic capital markets often lead sound corporate governance

practices, improved efficiency and better shareholder value.

Improvements to market efficiency

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

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

many domestic investors, it may be easier for a globally diversified portfolio manager

to be more stable about India's prospects, and engage in stabilizing trades. Second, at

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

knowledge and ideas about valuation of a firm or an industry can more rapidly

propagate into India.




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2. ENTRY OPTIONS FOR FII IN INDIA

FIIs (Foreign Institutional Investors) have been permitted to invest in all types of securities

including govt. securities. The investments by FIIs enjoy full capital account convertibility.

They can invest in a company under portfolio investment route up to 24% of the paid up

capital of the company. This can be increased up to the statutory ceiling, as applicable. The

recent initiatives by the Government for developing the corporate debt market, increasing the

ceiling on investment by FIIs in the domestic debt market and move towards convertibility of

rupee in the capital account are the positive factors, which have increased the FII inflows in

the country.

FII investments in India can be of the two types:

2.1.Normal FIIs : FII allocation of the 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.

The FII inflows into the primary market in India comes mainly through the conversion of

foreign Currency convertible bonds (FCCBs), private placement to qualified

institutions placements (QIPs), initial public offers (IPOs), follow-on overseas offers,

conversion of warrants and preferential offers .

2.1.1. Preferential Allotment of Shares

Every firm needs capital for investment. They need capital to meet expenditure like

expansion, diversification, modernization, M&A, etc., from time to time. When a

listed company doesn't want to go for further public issue and the objective is to raise

huge capital by issuing bulk of shares to selected group of people, preferential

allotment is a good option. A private placement is an issue of shares or of convertible

securities by a company to a select group of persons under Section 81 of the

Companies Act, 1956 which is neither a rights issue nor a public issue. This is a faster

way for a company to raise equity capital.




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A private placement of shares or of convertible securities by a listed company is

generally known by name of preferential allotment. A listed company going for

preferential allotment has to comply with the requirements contained in Chapter XIII

of SEBI (DIP) Guidelines, in addition to the requirements specified in the Companies

Act. In short, preferential issue means allotment of equity to some selected people by

a company which has its share already listed.

Advantages

One advantage of raising money via a preferential issue is that it helps save

cost and time involved in a public issue.

If the concerned company is not doing too well at that point in time but

requires capital, then retail investors may not want to participate in an issue.

At the same time, there could be some institutions which view the company's

troubles as being temporary and feel that some injection of capital could help

it out of the trough. In fact, promoters need such investors in times when the

market sentiment is weak and a public issue could fail. Moreover, if promoter

is being allotted preferential issue and they acquire more shares in the

company, it is a good sign because it shows that the corporate ship is not

sinking and they have abiding interest in the company.

There is no requirement of filing any offer document / notice to SEBI in

case of the preferential allotment and even no eligibility norm for the company

for the preferential allotment.

In the preferential allotment, these are issued in bulk and, hence, when huge

fund requirement is there without incurring much cost and without

investing much time.

In current scenario, where there is lots of takeover in preferential issues, the

shares are issued to friendly investors like promoters to ward-off the risk of

take over. If shares are issued to public, there is a chance that later they can

sell it to a firm which has an intension of take over.




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2.1.2. Qualified Institutions Placements (QIPs)

Primarily an issue can be classified as public issues, rights and private placements

(also known as preferential issues). QIPs are issued under the category of private

placements.

A private placement is an issue of shares or of convertible securities by a company to

a select group of persons under Section 81 of the Companies Act, 1956 which is

neither a rights issue nor a public issue. This is a faster way for a company to raise

equity capital. A private placement of shares or of convertible securities by a listed

company is generally known by name of preferential allotment. A Qualified

Institutions Placement is a private placement of equity shares or securities convertible

into equity shares by a listed company to Qualified Institutions Buyers only in terms

of provisions of Chapter XIIIA of SEBI (DIP) guidelines. The chapter contains

provisions relating to pricing, disclosures, currency of instruments etc. There are no

eligibility norms for a listed company making a preferential issue. However for

Qualified Institutions' placement (QIP), only those companies whose shares are listed

in NSE or BSE and those who are having a minimum public float as required in terms

of the Listing agreement are eligible.

Advantages

Investors subscribing to shares in relation to preferential allotment face a one

year lock-in period. The securities allotted pursuant to the QIP Scheme also

cannot be sold by the allotees for a period of one year from the date of

allotment but they can still do the same on a recognized stock exchange (even

within one year). This provision allows the investors an exit mechanism on

the stock exchange without having to wait for a minimum period of one

year. This advantage has also added to the preferential treatment received by

QIPs from investors.

Not more than 50 per cent of the equity can go to one investor. As such

mutual funds that are increasingly becoming as large an investor base as FIIs,

will now be able to participate in these issuances, thereby, creating a more

level playing field.




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As per SEBI guidelines, place ments can be made only to the qualified

institutions buyers which includes FIIs, SEBI-registered venture capital

funds, mutual funds, insurance companies and other institutional investors and

issuers would have to allocate a minimum of 10 per cent of such placements to

mutual funds. Promoters or those related to the issuers are barred from

participating in such issues.

2.1.3. FCCB

It is a type of convertible bond issued in a currency different than the issuer's

domestic currency. In other words, they are raised by the issuing company is in the

form of a foreign currency. A convertible bond is a mix between a debt and equity

instrument. It acts like a bond by making regular coupon and principal payments but

these bonds also give the bondholder the option to convert the bond into stock. These

are the debt instrument issued in a currency different than the issuer‟s domestic

currency with an option to convert them in common shares of the issuer company. It

is a quasi debt instrument that helps companies raise foreign currency funds at

attractive rates. FCCBs are similar to bonds as they make regular coupon (interest)

payments and also give the bondholder an option to convert the bond into stock.

Advantages

These types of bonds are attractive to both investors and issuers. The investors

receive the safety of guaranteed payments on the bond and are also able to

take advantage of any large price appreciation in the company's stock.

(Bondholders take advantage of this appreciation by means warrants attached

to the bonds, which are activated when the price of the stock reaches a certain

point.)

2.1.4. INITIAL PUBLIC OFFERING

Public issues can be classified into Initial Public offerings and further public

offerings. In a public offering, the issuer makes an offer for new investors to enter its

shareholding family. The issuer company makes detailed disclosures as per the DIP

guidelines in its offer document and offers it for subscription. Initial Public Offering

(IPO) is when an unlisted company makes either a fresh issue of securities or an offer




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for sale of its existing securities or both for the first time to the public. This paves way

for listing and trading of the issuers securities. IPO is new shares Offered to the public

in the Primary Market .The first time the company is traded on the stock exchange. A

prospectus is issued to read about its risk before investing. IPO is a company's first

sale of stock to the public.

2.2.100% 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.

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

2.2.1. As FIIs :

Overseas pension funds, mutual funds, investment trust, asset Management Company,

Nominee Company, bank, institutional portfolio manager, and 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 Investments on behalf of a broad-based fund (i.e., fund having more than

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

of the fund). Some of the above mentioned types are described below:

2.2.1.1. Pension funds

A pension fund is a pool of assets that form an independent legal entity that

are bought with the contributions to a pension plan for the exclusive purpose

of financing pension plan benefits. It manages pension and health benefits for

employees, retirees, and their families. FII activity in India gathered

momentum mainly after the entry of CALPERS (California Public

Employees‟ Retirement System), a large US-based pension fund in 2004.

2.2.1.2. Mutual funds

A mutual fund is a professionally managed type of collective investment

scheme that pools money from many investors and invests it in stocks, bonds,




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short-term money market instruments, or other such securities. The mutual

fund will have a fund manager that trades the pooled money on a regular basis.

The net proceeds or losses are then distributed to the investors.

2.2.1.3. Investment trust

An Investment trust is a form of collective investment .Investment trusts are

closed-end funds and are constituted as public limited companies. A collective

investment scheme is a way of investing money with others to participate in a

wider range of investments than feasible for most individual investors, and to

share the costs and benefits of doing so

2.2.1.4.

Investment banksAn investment bank is a financial institution that raises capital, trades in

securities and manages corporate mergers and acquisitions. Investment banks

profit from companies and governments by raising money through issuing and

selling securities in capital markets (both equity, debt) and insuring bonds (e.g.

selling credit default swaps), as well as providing advice on transactions such

as mergers and acquisitions.

2.2.1.5. Hedge funds

A hedge fund is an investment fund open to a limited range of investors that is

permitted by regulators to undertake a wider range of investment and trading

activities than other investment funds, and that, in general, pays a performance

fee to its investment manager. Every hedge fund has its own investment

strategy that determines the type of investments and the methods of

investment it undertakes. Hedge funds, as a class, invest in a broad range of

investments including shares, debt and commodities. Many hedge funds

investments in India were facilitated by global investors borrowing at near

zero interest rates in Japan and investing the proceeds in High interest markets

like India.

2.2.1.6. University Fund

The purpose of investments of these funds is to establish an asset mix for each

of the University funds according to the individual fund‟s spending

obligations, objectives, and liquidity requirements. It consists of the




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University‟s endowed trust funds or other funds of a permanent or long-term

nature. In addition, external funds may be invested including funds of

affiliated organizations and funds where the University is a beneficiary.

2.2.1.7. Endowment fund

It is a transfer of money or property donated to an institution, usually with the

stipulation that it be invested, and the principal remain intact in perpetuity or

for a defined time period. This allows for the donation to have an impact over

a longer period of time than if it were spent all at once.

2.2.1.8. Insurance Funds

An insurance company's contract may offer a choice of unit-linked funds toinvest in. All types of life assurance and insurers pension plans, both single

premium and regular premium policies offer these funds. They facilitate

access to wide range and types of assets for different types of investors.

2.2.1.9. Asset Management Company

An asset management company is an investment management firm that invests

the pooled funds of retail investors in securities in line with the stated

investment objectives. For a fee, the investment company provides more

diversification, liquidity, and professional management consulting service than

is normally available to individual investors. The diversification of portfolio is

done by investing in such securities which are inversely correlated to each

other. They collect money from investors by way of floating various mutual

fund schemes.

2.2.1.10.

Nominee CompanyCompany formed by a bank or other fiduciary organization to hold and

administer securities or other assets as a custodian (registered owner) on

behalf of an actual owner (beneficial owner) under a custodial agreement.

2.2.1.11. Charitable Trusts or Charitable Societies

A trust created for advancement of education, promotion of public health and

comfort, relief of poverty, furtherance of religion, or any other purpose

regarded as charitable in law. Benevolent and philanthropic purposes are not




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necessarily charitable unless they are solely and exclusively for the benefit of

public or a class or section of it. Charitable trusts (unlike private or non-

charitable trust) can have perpetual existence and are not subject to laws

against perpetuity. They are wholly or partially exempt from almost all taxes.

2.2.2. 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.

2.2.3. Domestic entity

A 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.

2.2.4. PARTICIPATORY NOTES

Another way of investing in the Indian market through FII‟s is through the use of

PARTICIPATORY NOTES. Participatory notes (PNs) are instruments used by

foreign funds, not registered in the country, for trading in the domestic market. Theyare a derivative instrument issued against an under lying security which permits the

holder to share in the capital appreciation/income from the underlying security. PNs

are like contract notes and are issued by FIIs, registered in the country, to their

overseas clients who may not be eligible to invest in the Indian stock markets. PNs are

used as an alternative to sub-accounts by ultimate investors generally based on

considerations related to transactions costs and recordkeeping overheads. FIIs invest

funds on behalf of such investors, who prefer to avoid making disclosures required by

various regulators. The associates of these FIIs generally issue these notes overseas.

The investors, who buy these notes, deposit their funds in the US or European

operations of the FII, which also operates in India. The FII then buys stocks in the

domestic market on behalf of these investors on their proprietary account. In this case,

the FII or the broker acts like an exchange: it executes the trade and uses its internal

accounts to settle the trade. This helps keeping the investor's name anonymous. Other

such instruments include equity -linked notes, capped return note, participatory return

notes and investment notes. Some genuine foreign investors often find it expensive to




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establish broker and custodian bank relationships, deal in foreign exchange, pay taxes

and/or filing, obtain or maintain an investment identity or regulatory approval in

certain markets, where their total exposure is not going to be very large. Such

investors look for derivative solution to gain exposure in individual, or a basket of,

stocks in the relevant market. The PN mechanism is favored by investors on grounds

of lower transactions costs and overheads. Sometimes, investors embark on

investment in India in a small way using PNs, and when their positions become larger,

they find it advantageous to shift over to a full-fledged FII structure.




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3. REGULATIONS IMPOSED BY INDIAN GOVERNMENT ON FII

There are several regulations imposed by SEBI on Foreign Institutional Investments under

“Foreign Institutional Investors Regulations 1995”. Following are some of important

regulations by SEBI:

1. A Foreign Institutional Investor may invest only in the following:-

Securities in the primary and secondary markets including shares, debentures and

warrants of companies [unlisted] listed or to be listed on a recognized stock

exchange in India.

Units of schemes floated by domestic mutual funds including Unit Trust of India,

whether listed on a recognised stock exchange or not.

Dated Government securities.

Derivatives traded on a recognised stock exchange.

2. The total investments in equity and equity related instruments (including fully

convertible debentures, convertible portion of partially convertible debentures and

tradable warrants) made by a Foreign Institutional Investor in India, whether on his

own account or on account of his sub- accounts, should be at least seventy per cent of

the aggregate of all the investments of the Foreign Institutional Investor in India,

made on his own account and through his sub-accounts.

3. In respect of investments in the secondary market, the following additional conditions

shall apply:-

a. the Foreign Institutional Investor shall transact business only on the basis of

taking and giving deliveries of securities bought and sold and shall not engagein short selling in securities.

b. No transactions on the stock exchange shall be carried forward.

c. The transaction of business in securities shall be only through stock brokers

who have been granted a certificate by the Board under sub-section (1) of

section 12 of the Securities and Exchange Board of India Act, 1992.

d. A Foreign institutional Investor or a sub-account having an aggregate of

securities which are worth rupees ten crore or more, as on the latest balance

sheet date, shall, subject to such instructions as may be issued from time to




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time by the Board, settle their transactions entered on or after January 15,

1998, only through dematerialized securities. ]

4. The limit for cumulative debt investment for FII investments in Corporate Debt is

USD 15 billion. This amount was changed from USD 6 billion to USD 15 billion in

March 2009.

5. USD 8 billion will be allocated to the FIIs and Sub-Accounts through an open bidding

platform while the remaining amount is allocated on a „first come first served‟ basis

subject to a ceiling of Rs.249 cr. per registered entity.

6. The debt investment limit for FIIs in government debt in G-secs currently capped at

$5 billion and cumulative investments under 2% of the outstanding stock of G-secs

and no single entity can be allocated more than Rs. 1000 cr of the government debt

limits.

7. Unless otherwise approved by the Board, securities shall be registered –

a. In the name of the Foreign Institutional Investor, provided the Foreign

Institutional Investor is making investments on his own behalf; or

b. In his name on account of his sub-account, or in the name of the sub-account, in

case he is investing on behalf of the sub-account: provided that the names of the

sub-accounts on whose behalf the Foreign Institutional Investor is investing are

disclosed to the Board by the Foreign Institutional Investor.

8. The purchase of equity shares of each company by a Foreign Institutional Investor

investing on his own account shall not exceed ten percent of the total issued capital of

that company.

9. In respect of a Foreign Institutional Investor investing in equity shares of a company

on behalf of his sub-accounts, the investment on behalf of each such sub-account shall

not exceed ten percent of the total issued capital of that company.

10. The investment by the Foreign Institutional Investor shall also be subject to

Government of India Guidelines.

11. A foreign Institutional Investor or sub-account may lend securities through an

approved intermediary in accordance with the stock lending scheme of the Board.




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4. REASONS FOR THE ATTRACTIVENESS OF INDIAN ECONOMY

FOR FII

“India get s more FII funds than Asian peers”

- The Hindu dated Nov 23, 2010

India had proved to be the most popular destination for overseas portfolio investors and

stock holders to park their fund in the Asian region for 2010. It shows the increasing

confidence in the Indian growth story, when the rest of the world is struggling to fight the

recession. Bloomberg data shows that foreign institutional investors (FIIs) have

purchased domestic equities worth $13.7 billion in 2010, making it the only Asian

markets to have received more than $10 billion of investment this year. It is 56% higher

than corresponding period of last year. This data is self sufficient to prove that India is

one of the best destinations to park your funds. FII investment into India is over 57%

higher than that of South Korean, which remains at the second slot in terms of overseas

investment followed by Indonesia, Taiwan, Thailand, Philippines and Vietnam. But the

question arises why India is so attractive in terms of FII when the manufacturing hub like

China and the other Industry rich countries like Japan, South Korea are easily available.

Following are the facts which make it the most attractive destination for the

overseas investors to invest in the second fastest growing economy of the world:

Draft direct tax code:- FII the key driver of Indian equity market had benefit a lot

from the draft direct tax code to help India the attractive option to invest. The direct

tax code would replace the Income Tax Act, 1961. The DDTC will help foreign

investor to enjoying the so-called double-taxation avoidance benefit. Double tax

treaties comprise of agreements between two countries, which, by eliminating

international double taxation, promote exchange of goods, persons, services and

investment of capital. These are bilateral economic agreements where the countries

concerned evaluate the sacrifices and advantages which the treaty brings for each

contracting state, including tax forgone and compensating economic advantages. A

majority of FIIs are registered in tax havens such as Mauritius and Singapore. These

countries have signed a double taxation avoidance agreement, or DTAA, with India

and the entities registered there enjoy tax exemption. Hence India benefits to its

overseas investor.




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Growth in GDP:- India is the 2nd fast growing economy after China and has been at

the forefront of emerging out of the recession at a break through speed. The growth

rate has jumped from 6.5 percent in 2009 to close to 9 percent this year. FII is

increasing like never before due to this growth in GDP and it further adds to the

sufficiency of capital in a country like India. Very high growth rates have the

potential of creating around 10-15 million jobs across the country across sectors.

Around 90% of these jobs would require skilled people at the forefront. This growth

rate had shown India to be one of the most potensial destination in the form of safety

of the money and the multiplication of money as the stock market is at its all time

high and touching 20,000 mark.

Friendly Government policies:- The government securities or G-sec are the most

safe securities with almost zero defaulter for the share holder. In order to develop and

boost long-term foreign investment, the government increased the investment limit for

foreign institutional investors (FIIs) in government securities (G-Secs) and corporate

bonds by $5 billion each. The cap in G-Secs and corporate bonds now stands at $10

billion and $20 billion, respectively previously it was $5 billion and $15 billion, hence

making Indian market the most attractive for the FII.

Political Stability:- Political conditions prevailing in a country also affect the stock

prices. For a steady economic growth a stable and effective government is required. In

absence of conducive political environment, the entire stock market is expected to

take a hit but in case of India it is been lead by one of the best economist of the world

Dr, Manmohan Singh, Present political scenario in India is very stable under UPA and

hence also help to increase the credit rating of India and hence will directly improve

the credit rating of companies doing business in India and hence attract more number

of investor.




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5. EFFECT OF FII ON INDIAN MONETARY POLICY

The Indian Markets have been one of the most attractive investment places on the globe

for the FII's. India being a developing nation attracts the foreign flows which are attracted

by the growth potential in the Indian Economy. There has been a sharp elevation in daily

inflows which has largely been attributed to the impressive IPO pipeline. It should also be

noted that these FII inflows have a huge effect on the common man. The same foreign

investors who bring large inflows to our country might flee with their profits when the

time‟s not right. This sharp reversal of funds flow might result in financial and economic

instability. The large build-up of foreign exchange reserves through FII inflows poses a

potential threat of destabilization of the economy. Portfolio flows are most often referred

to as “hot money” that can be notoriously volatile when compared to other forms of

capital flows. The Mexican crisis and the East Asian crisis are classic examples of the

damage that sudden outflows of portfolio money can do to an economy. Thus, India also

needs to focus on long-term flows in the form of foreign direct investment to sustain the

economic reform process.

5.1.Appreciation of The Currency:

While other things remain constant, higher FII flows help in the appreciation of

rupee. This allows Indian consumers to import foreign goods priced at a cheaper

price.

However, an appreciation in our currency also makes our exports uncompetitive in

the global markets. As India is a developing economy, it would be beneficial to have

a weaker currency which would improve exports and hence, generate higher domestic

activity.

Here‟s an example explaining the appreciation of rupee:

The foreign exchange rate of our country is 1 USD = 50 INR but after some time the

exchange rate fluctuate to 1 USD = 45 INR. This implies that the Indian rupees

appreciated over the US dollar. The logic is indeed quite simple.

E.g. if Indian customer want buy one quantity of chocolate from USA market (here

we suppose that price of 1 chocolate is 1 USD) he will have to pay 50 INR which is




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equal to 1 USD. But when exchange rate changes he will have to pay 45 INR instead

of INR which is equal to 1 USD.

In short purchasing power of Indian customer have rise now they will have to pay less

amount to buy ice cream or they can buy more quantity of ice cream at same price .

The fund inflows from Foreign Institutional Investors (FIIs), for the calendar year so

far, have topped a record $24 billion and the rupee is up 4.4 percent. The net FII

inflows touched a record USD 8 billion in September alone. It was the first time in

this year that the central bank had to intervene and they bought dollars from the

market in order to cool the rupee appreciation.

When FIIs come in India they create rupees demand and by the very creation of thisdemand and supply rule the price of INR and it appreciates.

5.2.Depreciation of the Currency

This implies that if the rate is USD = 45 INR, but after some time the rate becomes 1

USD = 50 INR that means rupee has depreciated over the USD.

For example: if India imports chocolate from USA then, earlier where they had to

pay 45 INR now they have to pay 50INR for the same unit.

Similarly if FII withdraws the capital from the domestic market or in other words if

they sell their share it create the demand for US dollar hereby creating a higher

demand for dollar and thus resulting in the depreciation of INR.

5.3.FII and exports:

There is an adverse effect on our economy as a result of appreciation of the Indian

currency solely because of FII. Due to this net inflow in India, there is adverse effect

on our export. Our export industry will become uncompetitive due to appreciation of

rupees.

E.g. if USD = INR 40 and a soap costs 1 USD. Now when the rupees appreciated 1

USD = 30 INR, the se ller will have to sell the same soap to the US for 2 USD in order

to sustain the same income that he has been making i.e. 40 INR.




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The logic is quite simple. First I sold my soap at INR which was equal to one USD.

But after appreciation I would like to sell 2 USD to get my same income that means I

will charge more US dollar from USA customer. Therefore, automatically with the

increase in price, the demand decreases among the customers.

The excess FII fund inflow in the country can also make a negative impact on the

economy of the country. In this situation our Indian IT industries, jewelry and textiles

industry affect.

The Indian exporters are finding it extremely difficult to cope up with the wide and

short term fluctuations in USD-INR exchange rate as they face heavy competition

from the other competing countries along with the less favorable status for Indian

Exports.

5.4.FII and stock market:

In case, when the cap on FII is high in that situation they can bring in lot of funds in

country‟s stock market. Thus they have great influence on the way the stock market

behaves, determining whether it will go up or come down. The FII buying pushes the

stock up and their selling shows the stock market down.

FII has started playing a major role in movement of stock prices and have led to build

a strong stock market infrastructure.

There has been an increase in the activity of stock exchanges with the advent of on

screen trading coupled with the clearance system which has lead to a new system

known as the depository system.

5.5.FII and inflation

The huge amount of FII fund flow creates the huge demand for Indian rupees in

which situation the RBI has to print more money in the market.

This situation in turn leads to excess liquidity thereby leading to inflation , where too

much money chase too few goods and service ( this is a perfect example of demand

pull inflation)




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Thus there should be a limit to the FII inflow in the country which should be taken

care by the government for the betterment of the common man.

5.6.FII and local companies:

With the advent of FII in any country, there is a huge availability of fund which is an

opportune moment for the local companies to expand their coverage.

5.7.Capital formation in domestic market

In case when there is sufficient FII inflow, the country will not borrow from other

countries or from international banks.

With the FII flows being high, the demand-supply equation comes into the picture

and the market tends to rise rapidly, in turn creating more wealth for the investor.

This positive wealth effect often leads to higher consumption and greater demand for

other asset classes such as gold, real-estate etc., which, in turn, fuels economic

growth. Higher FII flows can, thus, be seen to help create wealth through higher asset

prices.

As India is developing country plus its domestic saving is low compared to the otherdeveloped countries therefore there is need for FII inflow.

5.8.FII and the Hot Money Concept:

“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.




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We take an example: If RBI gives the interest rate 9% on foreign investor deposit

which being quite high in Asia attracts foreign investor in Indian market in order to

make capital gain. But simultaneously, if the Bank of China also raise their interest

rate to 10 % which being the highest in Asia will attract all FII from Indian market to

Chinese market.

This will continue to happen if any nation again increases the interest rate. Thus, the

FII inflows are very volatile. It has the capacity to disturb the economy at the time of

coming and going. And hence this concept is called the hot money concept




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6. IMPACT OF FII ON THE FISCAL POLICY OF INDIA

The fiscal policy of any country revolves around the use of government expenditure

and revenue generation from tax.

To ensure that sufficient FIIs make increasing investments in our country the

government of our country has been increasingly taking up a liberal approach in its

fiscal policies. Amendments have been made on the Income Tax Act 1961 by levying

just a 10% tax on the short term capital gains that the FIIs earn in the stock market.

Double Taxation Avoidance Agreements (DTAA) are a lso becoming beneficial to the

FIIs.

The stimulus packages that have been injected into the economy for the purpose of

reviving the economy post recession is a booster for increasing foreign institutional

investments in the country. It has greatly helped in restoring trust and faith.

FIIs have been a major driving force in the stock market post liberalization. They

form a major part when it comes to achieving our economic goals. Recessionary

trends had put most of the FIIs in the backseat but the conditions are improving now

and they are largely responsible for us to achieve our fiscal targets.

Government policies with regard to FIIs have been increasingly welcoming. A boost

in the FIIs can be expected if our fiscal policies are able to reduce the amount of

taxation made on the capital gains that the FIIs make in the stock market.

But at the same time in India the influx of FIIs is increasing at a compounding rate.

This has made the Central Bank start increasing its interest rates so as to suck the

excess liquidity in the market.




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7. FIIS AND THE INDIAN STOCK MARKET

The FII investments in the country‟s capital market have been steadily increasing

since 1992. They show a significant impact on the movement of the stock market

indices in India. It has shown increased influence on the domestic markets also

The movement of the SENSEX is largely governed by the FIIs. They have a great

impact on the market sentiments and price trends. Most market participants believe

that FIIs have a foolproof judgment about the market scenario and hence resort to a

herd mentality

Data on trading activity of FIIs and domestic stock market turnover suggest that FII‟s

are becoming more important at the margin as an increasingly higher share of stock

market turnover is accounted for by FII trading. Moreover, the findings of this study

also indicate that Foreign Institutional Investors have emerged as the most dominant

investor group in the domestic stock market in India. Particularly, in the companies

that constitute the Bombay Stock Market Sensitivity Index (Sensex) and NSE Nifty,

their level of control is very high. Dominant position of FIIs in the Sensex companies,

it is not surprising that FIIs are in a position to influence the movement of Sensex and

Nifty in a s ignificant way.

This dominance of FIIs in the market have made individual investors bank heavily on

Mutual Funds. These mutual funds are now creating collaborations with foreign

mutual funds and also adopting their kind of strategies. Unlike ordinary investors

Mutual Funds are also capable of polarizing the market.

Large share of FIIs in the equity capital of the company can put the firm in a

precarious situation in case of a pull out. Hence the FIIs are a major factor affectingthe financial health of the economy at large




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8. FOREIGN INVESTMENT FLOWS IN INDIA

One of the most important distinctions between Portfolio and Direct investment to have

emerged from this young era of globalization is that portfolio investment can be much

more volatile.

TABLE: Foreign Investment Flows in India

Year A. Direct Investment B. Portfolio Investment Total (A + B)

(US $ million) (US $ million) (US $ million)

1990-91 97 6 103

1991-92 129 4 133

1992-93 315 244 559

1993-94 586 3567 4153

1994-95 1314 3824 5138

1995-96 2144 2748 4892

1996-97 2821 3312 6133

1997-98 3557 1828 5385

1998-99 2462 61 2523

1999-00 2155 3026 5181

2000-01 4029 2760 6789

2001-02 6131 2021 8152

2002-03 4660 979 5639

2003-04 4675 11377 16052




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From a net foreign investment inflow of US $ 5.3 billion in 1997-98, such inflows declined to

US $ 2.4 billion in 1998-99. This is because of the lower portfolio inflows, as a result of

which the net investment has dropped. The changes in the investment conditions in a country

or region can lead to dramatic swings in portfolio investment. For a country on the rise, in

other words for developing countries, FPI can bring about rapid development, helping an

emerging economy move quickly to take advantage of economic opportunity, creating many

new jobs and significant wealth. However, when a country's economic situation takes a

downturn, sometimes just by failing to meet the expectations of international investors, the

large flow of money into a country can turn into a stampede away from it.

CHART: FOREIGN INVESTMENT FLOWS

Foreign Portfolio Flows to India

Foreign portfolio investments have been allowed in India on the basis of the

recommendations of the Narasimham committee which stated:

The committee would also suggest that the capital markets should be gradually opened up to

foreign portfolio investments and simultaneously efforts should be initiated to improve the

depth of the market by facilitating the issue of new types of equities and innovative debt

instruments.‟ (Narasimham committee report)

0

2000

4000

6000

8000

10000

12000

1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04

F O R E

I G N I N V E S T M E N T I N F L O W S

YEARFPI FDI




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Prior to 1992, only non-resident Indians (NRIs) and Overseas corporate bodies (OCBs) were

allowed to undertake portfolio investment in India. Only on September 14, 1992 the

Government of India issued guidelines on FII investments in India which was followed by a

notification by Securities and Exchange Board of India (SEBI) three years later in November

1995.




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9. TRENDS IN FII INVESTMENT IN INDIA

TABLE: Trends in FII investment

Year FII PURCHASE FII SALES FII NET FII NET CUM FII NET

in crores in crores in crores US$ million US$ million

1993-94 5593 466 5126 1634 1638

1994-95 7631 2835 4796 1528 3167

1995-96 9694 2752 6942 2036 5202

1996-97 15554 6979 8575 2432 7634

1997-98 18695 12737 5958 1649 9284

1998-99 16115 17699 -1584 -386 8898

1999-00 56856 46734 10122 2339 11237

2000-01 74051 64116 9934 2160 13396

2001-02 49920 41165 8755 1846 15242

2002-03 47060 44371 2689 562 15804

2003-04 144858 99094 45765 9949 25754

Source: Reserve Bank of India Annual Report 2004

The investments by FIIs have been registering a steady growth since the opening of the

Indian capital markets in September 1992. Their investments have always been net

positive, but for 1998-99, when their sales were more than their purchases.

It can be observed from the above table that the portfolio investment inflows have always

been on the increase. But the years 2001-02 and 2002-03 saw some reversal in the trend.

From a net inflow of US $ 2.1 billion in 2000-01, such inflows declined to US $ 1.8

billion in 2001-02, and further dropped to US $ 0.562 billion in 2002-03. The decline is




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because of the lower portfolio inflows, as a result of which the net investment has

dropped in these years. However, this decline witnessed a sharp reversal in the year 2003-

04. FIIs have made a net investment of Rs. 45,764 crores during this year registering a

growth of 1602% over the previous year, creating a record in the history of FII investment

in India. Gross purchases in this year amounted to Rs.144,857 crores, a growth rate of

208% compared to the year before. This trend continued in April 2004, only to suffer

reversal again during May and June 2004, when the net investment became negative.

Fortunately, the year from July 2004 has been seeing a net positive portfolio flows by

FIIs. As of September 2004, the net FII portfolio investment stands at US $ 27,637

million. If it is so, then increasing the FII investment cap per se will not be helpful. The

country has to work on specific measures to encourage more FII investments. The

analysis of data indicates that there has been substantial divestment by the FIIs during the

year 1998-99. The maximum outflow was during the months of May and June 1998

(almost US$430 millions).

CHART : GROWTH OF FII INVESTMENTS IN INDIA

The trickle of FII flows to India that began in January 1993 has gradually expanded to an

average monthly inflow of close to Rs. 1900 crores during the first six months of 2001.

By June 2001, over 500 FIIs were registered with SEBI. The total amount of FII

investment in India had accumulated to a formidable sum of over Rs.50,000 crores during

this time. In terms of market capitalization too, the share of FIIs has steadily climbed to

about 9% of the total market capitalization of BSE (which, in turn, accounts for over 90%

of the total market capitalization in India).




10. BIBLIOGRAPHY

www.mbaknol.com

www.differencebetween.net

www.theviewspaper.net

www.coolavenues.com

www.finance.mapsofworld.com

www.finance.indiamart.com

www.indiastudychannel.com

SEBI Act.,

www.mbaknol.com

www.wikipedia.com

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