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Importance Of Fii And Fdi Investment In India Finance Essay

The paper examines the importance of FII and FDI investments in India. The paper attempts to find out whether fund inflows of FDI and FII are real boon for India or just an illusion. After analyzing the data collected, we can conclude that they play an important role in the growth of the India and shows a positive pattern between the Indian capital market and the inflow of funds into India through FII and FDI.

Introduction

Indian Markets are considered as one of the most attractive investment places for the Foreign Institutional Investors (FII) and Foreign Direct Investors (FDI). Indian economy shows a great potential to attract the foreign flows being invested into the country. In the year 2010, FII's contribute a major chunk of volumes on the Indian stock market which in turn have impacted the market moves and allowed to reach to new record breaking levels. When almost all the countries were hit by recession and their economies were in turmoil, the foreign investors look towards India for saver bets. India with a rising Gross Domestic Product (GDP) where other nations GDP/ Growth was shrinking, offered greater investment avenues. Indian Markets have been the clear outperformers with respect to the global markets in the past years.

As far as FDI in concerned, India is ranked 3rd in the global foreign direct investments in 2009. According to the United Nations Conference on Trade and Development (UNCTAD), it is projected that India would remain among the top five countries for investors for 2010-2011.

FDI is more of a permanent mature, associated with export growth. When FDI meets all the parameters to set up an export industry, their existence is known. Parameters includes, subsidy in taxes, encouraging labor law, easy inflow and outflow of money out of the country, government’s help to acquire land, develop infrastructure, reduced bureaucratic involvement etc. Key sectors for foreign investment includes: Telecommunications, Information Technology, Business Process Outsourcing (BPO), Automobile Industry, Pharmaceuticals, unexplored service sectors including accounting; drug testing, medical care etc. Manufacturing is more of a permanent investment. They look for long term growth in the country. Large investment funds are needed to set this industry. Manufacturing industry gives employment potential to semi skilled and skilled labor. But, service sector requires fewer but highly skilled workers. Both industries play a significant role and are necessary for India success.

The FII (Foreign Institutional Investor) is investment, which chases the secondary market. It is not exactly a permanent investment, but in the long run it may become one the kind .FII are too cautious about their investments and reacts to the smallest political or economical disturbance. Key example to support the latter statement is the late nineties disaster of economy of Asian Tigers. Once such incident happen only debris of ruined life and ruined economy is witnessed. Hence FII is to be welcomed with strict political and economical discipline.  

In this context, the report focuses on examining the trends and patterns of FDI and FII flows into India and will it really help to write India’s growth story or its just an illusion.

OBJECTIVE

Understand FDI and FII and the difference between them

Examine the trends and pattern of FDI inflow in India from different countries and across different sectors from 2000-2010(September 30th).

Impact of FII investment on the momentum of Indian capital Market from the period of 2007-2010(till September 15th).

Methodology

Following methods have been adopted to successfully achieve the objective of the seminar paper.

Data Collection

Secondary data has been used: Internet, journals and books, other reports and projects.

FDI:

Top 10 investing countries have been taken into account. They are Mauritius, Singapore, USA, UK, etc.

Top 10 sectors which have larger inflow of FDI from different countries are taken into account. They are computer hardware, telecommunications, and service sector and computer software.

FII:

For the analysis of the market trend with respect to the FII inflow in India during the period from March’07- September (till 15th September)’10, Nifty Top 50 Index is considered.

Definition and Difference between FDI and FII

FOREIGN DIRECT INVENTMENT (FDI): The OECD benchmark definition of FDI is:

Foreign direct investment reflects the objective of establishing a lasting interest by a resident enterprise in one economy (direct investor) in an enterprise (direct investment enterprise) that is resident in an economy other than that of the direct investor. The direct or indirect ownership of 10% or more of the voting power of an enterprise resident in one economy by an investor resident in another economy is evidence of such a relationship.

According to economic theory, the three principal contributions of FDI to a host country are:

(1) The foreign capital invested by foreign firms

(2) Access to the export market which they provide

(3) Rapid development in the technological perspective through technology transfer which is part of the FDI deal.

All the above principle assists the host nation to achieve faster growth in all industry which else would not be feasible easily. First two principles are examined by analyzing the stake of FDI in total external inflows into the host economy and gross domestic capital formation, the ownership of foreign investors in different sectors in composition of industry FDI inflow and sources of inflow and the orientation of the firm in terms of the foreign investment.

Foreign Institutional Investor (FII):

It is defined as an institution or individual investor from or registered in the country outside the one in which it is currently investing. The company has to abide by the rules and regulations of the country in which it is making investments.

FII includes the following:

Overseas Pension Funds

g) Bank

Mutual Funds

h) Institutional Portfolio Manager

Investment Trust

i) University Funds

Asset Management Company

j) Endowments

Nominee Company

k) Charitable Trusts

Foundations

l) Charitable Societies

Any domestic investor wants to invest on behalf of funds established outside country are qualified to be registered as FIIs:

Asset Management firms

Managers managing Institutional Portfolio

Trustees

POA (Power of Attorney) Holders.

FII invests in two ways:

1) They invest their own funds,

2) Invests on behalf of their clients which are registered as “sub-accounts” under SEBI.

Apart from the above mentioned ways a domestic portfolio manager can also manage the foreign clients funds after registering itself under SEBI as an FII to manage the funds.

Difference between FDI and FII

FDI and FII are related to the investment in the foreign countries but there are differences in the way they invest and their characteristics.

Foreign Direct Investor

Foreign Institutional Investor

An investment that a parent company makes in a foreign country

An investment made by an investor in the markets of a foreign nation.

Invest with broader perspective to acquire physicals assets ,etc.

The companies only need to get registered in the stock exchange to make investments

Regulated by Reserve bank of India in India

Regulated by Securities and Exchange Board of India in India

High entry and exit barriers

Low entry and exit barriers

Investment in targets a specific enterprise

Investment to increase capital availability in general.

More Stable

Less Stable

Long term

Short term

Foreign Direct Investment

In Indian scenario following forms of investments are permissible for FDI:

Restricted areas:

Arms and ammunition

Atomic Engineering

Industry of Coal and lignite

Indian Rail Transportation

Mining Industry which includes metals like gold, diamonds, copper, chrome, gypsum, zinc, iron, manganese, and sulfur.

I. Foreign Investment through GDRs (Euro Issues)

Global Depository Receipts (GDRs) are treated FDI when in companies raise equity capital in the international market. Currency used is dollars (U.S) and investment is not subjected to any ceilings. A company should have a track of good performance for the minimum of 3years for seeking Government's approval. Exception is infrastructure projects such as power generation, telecommunication, petroleum exploration and refining, ports, airports and roads.

1. Clearance from Foreign Investment Promotion Board (FIPB)

Companies or group of companies can have as many number of Euro-issue to be floating in the financial year. For manufacturing companies who follow New Industrial Policy whose FDI wants to raise Euro issue and is likely to exceed 51% or executing a project not approved under Annexure-3 regulations, would require a prior FIPB clearance before getting approval from Ministry of Finance.

2. Global Depository Receipt (GDR) Uses

GDRs can be used for equipment and building and investment in software development, financing capital goods imports, capital expenditure including domestic purchase/installation of plant, equity investment in JV/WOSs in India and prepayment or scheduled repayment of earlier external borrowings.

II. Routes for Foreign direct investments in India approved by Government of India

1. Automatic approval by RBI

Automatic approvals are granted to all proposals and foreign equity up to 24%; 50%; 51%; 74% and 100% by the Reserve Bank of India within a period of two weeks (subject to compliance of norms).

The list includes almost all industries of interest to foreign companies. Investments in high priority industries or for trading companies are given priority for approvals from the RBI.

2. Non-automatic processing of cases for approval using FIPB route

FIPB approves all other cases where the parameters of automatic approval are not met. Processing time is 4 to 6 weeks. Rejections are few and approvals are moderate for all sectors.

When the foreign investor owns less than the total equity of the firm, no mandatory rules exists for the foreign investor to have domestic investors

III. Analysis:

a) Sector specific policy for FDI

Sr. No.

Sector/Activity

FDI cap

Entry/Route

1.

Hotel & Tourism

100%

Automatic

2.

NBFC

49%

Automatic

3.

Insurance

26%

Automatic

4.

Telecommunications

cellular, value added services

ISPs with gateways, radio paging

Electronic Mail & Voice Mail

49%

74%

100%

Automatic

Above 49% need Govt. license

5.

Trading companies:

primarily export activities bulk imports

cash and carry wholesale trading

51%

100%

Automatic

6.

Power(other than atomic

reactor power plants)

100%

Automatic

7.

Drugs & Pharmaceuticals

100%

Automatic

8.

Road, Highways, Ports and Harbors

100%

Automatic

9.

Pollution Control and Management

100%

Automatic

10.

BPO

100%

Automatic

11

Call Centres

100%

Automatic

12.

For NRI's and OCB's:

i. Projects related to tourism and hotels

ii. Thirty four High Priority Industry Groups

iii. Export Trading Companies

iv. Hospitals, Diagnostic Centers

v. Shipping Industry

vi. Deep Sea Fishing

vii. Exploration of OIL

viii. Power sector

ix. Real Estate and housing

Development

x. Highways, Bridges and Ports

xi. Industries Reserved for

Small Scale Sector

xii. Sick Industrial Units

xiii. Industries Requiring Compulsory Licensing

100 %

Automatic

13

Airports:

Greenfield projects

Existing projects

100%

100%

Automatic

Beyond 74% FIPB

14.

Asset 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

b) Year wise FDI Investment in India

S. NO

Financial Year

Total FDI Inflows

% growth over Previous Year

1

2000-01

4029

----

2

2001-02

6130

+52%

3

2002-03

5035

-18%

4

2003-04

4322

-14%

5

2004-05

6051

+40%

6

2005-06

8961

+48%

8

2006-07

22825

+146%

9

2007-08

34362

+53%

10

2008-09

35168

+1%

11

2009-10

37182

+6%

12

2010-11(September 30th)

13508

------

c) Share of top ten investing countries FDI equity in flows

S.NO

Country

Amount of Foreign Direct Investment Inflows

In Rs. Crores In U.S$ (million)

%age with total inflows

1

MAURITIUS

228,626.29

51,088.54

42.12

2

SINGAPORE

50,328.76

11,329.38

9.34

3

U.S.A.

40,538.11

9,001.88

7.42

4

U.K.

27,506.69

6,211.53

5.12

5

NETHERLANDS

22,414.82

4,984.96

4.11

6

CYPRUS

19,698.03

4,314.32

3.56

7

JAPAN

19,446.74

4,277.63

3.53

8

GERMANY

12,832.16

2,878.35

2.37

9

FRANCE

8,313.48

1,831.18

1.51

10

U.A.E.

8,152.28

1,791.97

1.48

d) FDI inflows from the period April 2000 to September 2010(Sector wise)

S. NO

Sector

Amount of FDI Inflow

In Rs. Crores In US$ million

%age with total inflows

1

Services Sector

114,735.90

25,667.73

21.16

2

Computer Software & Hardware

46,285.12

10,406.16

8.58

3

Telecommunications

45,508.80

9,988.01

8.23

4.

Housing & Real state (Including Cineplex, Multiplex, Integrated Townships & Commercial complexes Etc.)

40,326.02

8,996.46

7.42

5.

Construction Activities

37,215.60

8,384.52

6.91

6.

Power

24,276.06

5,355.91

4.92

7.

Automobile Industry

5,355.91

4,776.18

3.94

8.

Metallurgical Industries

17,610.52

4,038.67

3.33

9.

Petroleum And Natural Gas

13,907.71

3,190.94

2.63

10

Chemical(except Industries)

12,048.84

2,663.59

2.20

Till September 2010 sector which received the largest shares of total FDI inflows is service sector and computer software and hardware sector which accounts for 21.16 and 8.58.

Manufacturing, Information, Professional, Scientific and Technical services are the top sectors attracting FDI into India via M&A activity. Indian government keeps a close watch and corresponds closely with these sectors as they are attracting the largest shares of FDI inflows overall.

Government raised the FDI limit in 2009 in telecom sector from 49% to 74%, which has contributed to the robust growth of FDI. Thus telecom sector grows 103% during fiscal 2008-09 as compared to previous fiscal. The sector attracted USD 2558 million FDI in FY ‘09 as compared to the USD 1261 million in FY ’08, acquired 9.37 per cent share in total FDI inflow. India automobile sector recorded 70% growth in foreign.

Housing and Real Estate (28.55%), Computer software and hardware (18.94%), Construction activities including road and highways (16.35%) and Power (1.865) are the other sectors which registered growth in highest FDI inflow.

Foreign Institutional Investor (FII)

I. Introduction

Market crisis broke out in late 1990’s. Experts as well as policymakers started examining the role of FII. A general perception was held that FII are speculators and they invest for short – term gains. This behavioral bias is believed, may affect in overreaction and lead to the bad financial crises

But, Indian liberalization process in 1992, rules and regulations were modified and FII’s were allowed to invest in Indian capital markets. This all was done under New Industrial Policy which was a part of the reform process. Since then GOI continue to lower entry/exit barriers for FII’s. Number of FIIs registered under SEBI surged up from 492 in March 1999 to 2304 by September 2010.

II. Indian Capital Market design for Foreign Institutional Investor

In April 2003, Government of India set up a committee for organizing all the procedures related to FIIs. They also assisted in recommending changes in the SEBI registration process, and the dual approval process of RBI and SEBI should be converted into single approval process. All their suggestions and recommendations were implemented in December 2003.

At present, eligibility criteria for foreign investors to invest under the FII route as follows:

i) As FII: University funds, Foundations, charitable trusts, charitable societies, investment trust, overseas pension funds, mutual funds, asset management company, nominee company, bank, institutional portfolio manager and endowments.

ii) As Sub-accounts: It includes foreign corporations/individuals/institutions/funds established or incorporated outside India on whose behalf investments are proposed to be made in India by a FII. Eligibility criteria for them is to get registered as sub-accounts, via public company, partnership firms, private company, pension fund, investment trust, and individuals.

FIIs fall under two categories

a) Routine FIIs: to invest minimum of 70% of their investment in equity-related instruments and 30 % in debt or any other non-equity instruments.

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

III. Restricted areas for Investments:

Restriction has been imposed on FIIs to invest in equity issued by the companies responsible for Asset Reconstruction Management. They are also not prevented from investing in any company which is engaged/proposes to engage in activities like:

1) Agricultural or plantation activities

2) Business of chit fund

3) Nidhi Company

4) Construction of farm houses or real estate business (excluding development of roads or bridges, townships, and construction of residential/commercial premises).

5) Trading in Transferable Development Rights (TDRs).

IV. Analysis

Trend of Foreign Institutional Investors (FII) in Indian capital markets

Investments in Global Depository Receipts (GDRs)/ American Depository Receipts (ADRs), Foreign Institutional Investments and investments in offshore funds are included in Portfolio investments in India. Pre-liberalization process (1992), Overseas Corporate Bodies and Non-Resident Indians (NRIs) were allowed to carry out portfolio investments in India. From 1992, they were allowed to invest in Indian capital market as well. Permission was granted to invest in both primary and secondary markets including equity and other securities of listed companies on stock exchanges in India.

Table: Comparison of movement in Nifty with FII investment for the period March’07-December’07

As we can see in the table above for the given period (March’07- December’07) Nifty increased by 2317 points (60.63%) and the FII flows been on a constant rise with total FII inflow during this period has been Rs. 63754.600 Crores.

Table: Comparison of movement in Nifty with FII investment for the period January’08-December’08

Year 2008 has been in contrast to the year 2007; Nifty plunged to a low of 2252.75 in Oct. 2008 after touching the mark of 6357 in Jan. 2008 to as. On monthly closing basis the Nifty Index lost 2187 points (5137.45 in Jan 08 to 2959.15 in Dec. 08). And, as we can see the FII’s are the net sellers during the period with the drop in investment to -52987.4 Crores.

Table: Comparison of movement in Nifty with FII investment for the period January’09-December’09

Year 2009 showed a positive trend with Nifty surged to 5201.05 in December 09 from 2874.80 gaining 2326.25 points (80.91%); Investors who adopted the strategy of buy and hold were facilitated by good returns.FII flows increased to 83424.20 crores during the period.

Table: Comparison of movement in Nifty with FII investment for the period January’08-September 15th, 2010

Year 2010 witnessed some of the most promising upward movement in the markets. Nifty touched the levels of 5860.95(as on 15th September) from the levels of4882.05 (January 2010) gaining around 978.90 points. FII’s continue to show faith in the Indian economy and market in the total inflow of Rs. 68321.80 crores during the period (January’2010 to September 15th, 2010)

Graphical Representation of the total flow of FII and the Nifty movement from March’2007 to September 15th ,2010

After interpreting the above graphical representation of the data, we can conclude that Indian markets are affected by the amount of FII investments in the country. Thus, foreign Institutional investors are vital to the Indian markets and regulatory bodies should keep a track of it.

One of the most significant characteristics of this graph is its symmetry. We can see that during January’2009 and February’2009 as the FII inflows were reduced, the movement of the Nifty also showed a downward side. Similarly during February’2010 and March’2010, when FII inflows in the country increases, Nifty also showed an upward movement. Therefore, a strong co-relation can be observed during the period considered. FII investments continue to impact the Indian markets significantly.

Thus, year 2007 saw a boom in the markets because of large fund inflow by the FIIs. Global economy crisis in the year 2008 severely impacted the Indian market as major part of fund outflow was seen because of the sell-off trend by the FIIs.

Markets recovered in the year 2009 as the government assured of the stable economy of the country and offering relief packages. FII continue to show faith in the growing economy of India and continue the process of fund inflow. GDP (Gross Domestic Product) continue to boost, stable political government and other business ventures continue to attract the foreign investments in the Indian markets.

V. FII investment co-relation with other Indian market indices and sectors

Indices

Co-relation with Foreign Institutional Investment

Bankex

0.21

Sensex

0.81

Information Technology

0.15

Power

0.35

Capital Goods

0.46

Observing the above table we can conclude that inflow of funds from FII has a impacts all the indices of Indian stock market. Highest co-relation is observed between Sensex and FII investment which shows a positive sign for the Indian economy. It also shows that FII mostly invests in reputed and big companies.

FIIs have also shown interest in Power and Capital goods sector.

Conclusion

India is emerging as a global player with its rapid growth in the economy on the worldwide scale specifically for the service sector. Fund inflow through FII and FDI gives chance to the country to witness the exposure of the foreign capital. Post liberalization (1992), inflow of the funds shows an upward trend.

From the findings and data analyzed we can conclude that both FDI and FII are important for India. They play a significant role to help in India to have a definite level of stable economy, growth and development. Thus, positive inflow of foreign funds through FII and FDI is boon for India. But, the Government of India along with regulatory bodies has to take care to monitor their activities periodically and reviewing their policies.

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