Impact of foreign institutional investors on Indian stock market



Generalities of Study


In the initial period the economic growth of all the countries were started by government planning and action by developing the agricultural, manufacturing and the infrastructure facilities of the country. Though these facilities were adequate for the economy but it didn't boost the domestic growth of the country as it did not lead to much saving or any further investment. Since these domestic savings were inadequate, countries had to depend on the loans from different countries for the development of their country through different public organisations. This led to growth of economies by increased foreign investments which came in the form of overseas loans. Foreign capital plays a significant role in the development of any economy. It fills the gap between domestic savings and its required investment for growth. But this investment limited the scope of growth as loans were not easily available. So countries induced foreign investments by allowing them to invest in the companies listed on stock markets to a major extent. This led to development of stock markets.

Stock Markets initially were just a way for people to invest their money into different companies and they were not that big. But as of today they have become an important part in the growth process of any country. Due to development of stock markets, economies are getting globalised and world is getting smaller. Hence the significance of stock markets has grown above leaps and bounds. As of today the Gross Domestic Production of a country largely depends on stock markets. As a result each country is trying to enhance its stock markets in order to attract foreign investments and to boost the growth process of their own country.

The best decision of the century has been the financial liberalisation of the equity markets all over the world which gave opportunity for foreign investors to invest in domestic markets especially of the emerging economies. According to Lalitha, S (1992), the main reason for opening stock market for FIIs was to attract foreign investments and stop country from raising more debts. According to Cerny (2004), the behaviour of stock market is affected by the globalisation of the world economy.

The Foreign Investors are eyeing these days on the Asian markets specially India due to many obvious reasons. First of all growth potential in Asian Markets is higher, secondly its cheaper in countries like India to invest as the costs are low, thirdly there is a higher investor base and fourthly mostly the Asian economies are developing and hence the Governments are welcoming to Foreign investors as they play a major role in boosting the growth of the country.

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Now the question that arises is who are Foreign Institutional Investors? According to SEBI, FII means an entity which is established or incorporated outside India and which proposes to make investments in India. According to Sehgal and Tripathi (2009) FIIs are speculators instead of investors as they tend to invest in stock for short term and after attaining short term gains they tend to move away to different company and this might lead to volatility in stock prices and may lead to financial crisis. FIIs investments in stock market increases volatility in market due to excessive liquidity but it also leads improvement in value of stocks.

According to Choe et al., (1999) & Froot et al., (2001) & Griffins et al., (2002), Foreign Investors run after returns from stocks, in a way they will buy shares in those companies whose returns they expect to be high. According to Syste et al. (2003), Foreign Investors invest in large liquid companies which enable them to exit quickly at lower cost. Another research by Prasana (2008) Foreign Institutional Investors have been eyeing on Indian Markets because of the positive fundamentals of the economy and potential to grow fast. Since foreign investors are freely available and are unpredictable, therefore FIIs are always on look out for profit. FIIs move their investments regularly and because of these swings there is a tendency to be fluctuations in prices and hence increased volatility in the market. Another study by Clark and Berko (1997) finds that stock prices rises due to increase in capital flows by foreign institutional investors but they could not conclude that the rise in prices are for short term or for long term. Another finding which indicates positivity of presence of FIIs was produced by Banaji (2000). According to him, due to presence of FIIs in Indian market there has been improved transparency in the procedures, automation and regulations regarding disclosure and reporting standards were initiated. So it becomes the necessity to study the Impact Foreign Institutional Investors have on Indian Stock Market.

Background of Indian Economy

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India was ruled for nearly 200 years by British rule and in 1947 it gained its independence.( So the growth of India has come in the last 60 years in which Indian economy has been thriving to set its foothold in the world. Under the British rule India was mainly dependent on its agricultural production and few basic industries were in existence as in textile industry which was basically for the benefit of the British colony to support them in their trade for European goods by exporting Indian basic agricultural goods and textile manufactures.

After Independence, India carried on with its policy of attaining self sufficiency and closed the doors for the foreign investors. But this policy of government limited the growth of economy. So in order to finance the needs to economy of providing basic necessities to its citizen's and for getting over with the burden of loans as the foreign reserves were at their all time low, Government of India took support from World Bank and International Monetary Fund to get the country on to revival path. These organisations agreed to help Indian economy on the condition that they will allow foreign investors to enter India.

So basically a reform process was initiated in India after balance of payment crisis of 1991 which was recommended by M. Narsimham, chairman of committee of financial system. This became starting point of deregulation of financial sector and development of various sectors of financial markets. This resulted in significant changes in Indian market from dull to highly buoyant stock market. As a result Indian markets were opened to foreign institutional investors in September 1992 and this event led to effective globalising of the financial services and since then the Foreign Institutional Investments have been rising positively year on year. These investments helped India in developing infrastructural facilities which were necessary for the growth of the country. These investments were led due to increasing confidence in Indian stock markets which were based on strong macro-economic fundamentals of the economy, abolition of long term capital gain tax, improved performance of Indian companies and transparency in the regulatory system.

The opening up of markets for foreign investors had its own pros and cons. Pros of financial liberalisation are that firstly stock markets had to improve its trading mechanism and match up to world standards and secondly with the presence of foreign investors, information system saw a drastic change. Con of financial liberalisation was that it brought destabilisation in the economy and increased more volatility in stock movements. But overall it increased confidence of foreign investors in Indian stock market. The last two decades has led to growing participation of Institutional Investors which includes not only the foreign Institutional investments but also investments by domestic institutional investors.

Indian economy has been an attractive avenue for foreign investors as nearly 16% of the world population lives in India and also India has joined the elite club of 12 countries to cross trillion dollar economy. Other countries which have in past breached this trillion dollar economy mark in the past includes countries like U.S, Japan, Germany, China, France, U.K, Italy, Spain, Canada, Brazil and Russia. Besides this country's stock Market capitalisation has also risen to $944 billion which is close to trillion dollar level. As per Credit Suisse Report, stock markets have risen in eight out of ten countries after reaching this mark.

Foreign Institutions have played a major role in Foreign Investments in India which resulted in changing the face of Indian Stock Market. According to M Puri, ICICI Securities Chief, ( 2009) India has been looked upon as the safest destination for foreign investors. Foreign Institutional Investors are the companies which are registered outside India. They are registered with Securities and Exchange Board of India and they are guided by SEBI in participating in stock market through limits placed by it. The major source of their investment in Indian Stock market is through Participatory notes which are almost 50% of the money invested in markets. The disadvantage of participatory notes is that the investor is anonymous and hence it could be an investment by any organisation including terrorist organisations. Foreign Institutional Investors have invested more than $41trillion of funds in India in the past four years which resulted in bull market witnessing unprecedented growth with BSE Sensex rising in absolute terms. India has witnessed over a decade of FIIs portfolio flows and these flows have gained significance and have played a key role in the overall Indian Economy.

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The impact of foreign investments in India is significant. The increasing role of Institutional investors led to both qualitative and quantitative developments in Indian Stock Markets. The Foreign institutional investors has also impacted the domestic investors to a large extent in the sense that if FIIs sell the stocks then there is a situation of panic created among the domestic investors and they tend to sell as well. Hence there is a need to study its impact on Indian companies and economy in general taking into consideration all the factors affecting movement of stocks on Indian Stock Market.

Significance of Study

Indian economy is growing at a very fast pace. Most of the FIIs are investing in India due to its significant growth. These FIIs though they are investing in the country, they not only invest for profit they also are affecting the movement of stocks in stock markets. Hence they are impacting the stock market in a large way which is an important perimeter of the Indian economy as it contributes to the growth process of Indian Economy. So it is significant to study the impact of Foreign Institutional Investments on Indian Stock Market.

Objectives of Study

The main objectives of study are:

  1. To analyse the impact of FIIs investments on the shareholding pattern of Stock exchange companies.
  2. To find way to reduce risk associated with investing in stock market and to know when to exit.
  3. To look for investment opportunities


Review of Literature and Studies

Determinants of FIIs

Foreign Institutional Investors play a major role in the economic growth of India. Their impact is significant even though their market capitalisation is not much and is improving year on year. Several attempts have been made to understand the impact FIIs have on Indian Stock markets. According to Aggarwal 1997, Chakrabarti 2001 and Trivedi and Nair 2003(cited in Rai and Bhanumurthy) equity returns have positive impact on FIIs. But Gordon and Gupta,2003 ( as citied in Rai and Bhanumurthy) contradict by saying that foreign investors are here for earning profits, they invest in a company and make the price go up as other investors follow and then book their profits and leave. So it can be said that there is a bidirectional relationship between FIIs and equity return.

After the bursting of infotech bubble in 1998 and Asian crisis, Chakrabarti (2001) analysed and found a shift in regime in the determinants of FIIs. He analysed that before the Asian crisis, any change in investment pattern by FIIs had a positive impact on equity returns but after Asian Crisis he found that if there is a change in equity return then the behaviour of FIIs change. But Trivedi and Nair (2003) are of a different view point, they feel that any investments made depend a lot on the risk associated with it. They further divide realised risk into two factors, ex-ante and unexpected risk. According to them, ex-ante risk is negatively related to FIIs whereas the relation of FII with unexpected risk is not certain. This is because uncertain activities can bring unimaginable loss or gain depending on the situation. Take for example U.S subprime crisis. Those crises were unexpected and they led to unexpected movement in stock markets and FIIs activity.

Studies in the past have concluded that the return in source country and inflation in that country doesn't exert pressure on FII. But this theory has been contradicted by the recent subprime recession in US which led to most of FIIs withdrawing their investments in order to cope up with crisis in their own country. Hence if stock markets of foreign investor's home country are doing well and there is stability in their economy then it leads to a positive impact on the investments by FIIs.

According to Aggarwal 1997 (as cited in Rai and Bhanumurthy 2004) world stock market capitalisation has a positive impact on growth of FIIs in India. According to literature survey shows that most of the existing studies do not reflect the effect of stock volatility and also they do not account for realised risks in foreign and domestic markets.

Another observation by Ahmadjian and Robbins (2005) after analysing firms in Japanese economy showed that foreign investors are more inclined towards profit making than going in for long term ownership. They tend to make money and move away towards other company.

Investment Preferences of FIIs

According to Douma, Pallathiatta and Kabir (2006) there is a positive impact of foreign ownership on firm performance and especially on the emerging economies. They also found the impact on business group affiliations of FIIs But FIIs don't invest in any firm, they invest in those firms which have good corporate governance as the firms with poor corporate governance are least protective about the investors and instead they are concerned about their own interest only, this was observed by Aggarwal, Klapper and Wysocki (2005). According to them companies which are controlled by block of shareholders they find it difficult to find external investors as they are derived by private benefits and may manipulate things accordingly. This was already concluded by Cho and Padmanabhan 2001 (as cited in Prasana 2008) that block shareholders influence firm performance. They also said that corporate governance of listed companies play an important role in attracting foreign investments. They also clarified that block shareholders mean basically businesses run by family groups and distinguished them from times when government acts as block shareholders; they act quiet differently from private investors. Bhanumurthy and Rai (2003) made an attempt to examine the determinants of FIIs by using the monthly data from January 1994- November 2002 by analyzing the effect of return, risk and inflation in domestic and foreign economy. They firstly calculate the domestic and foreign returns from daily returns on BSE Sensex and S&P 500. After the analyses they find out that FIIs inflow depend on stock market returns, inflation rate and Ex-ante risk.

According to Yin-Hua and Woidtke 2005 (cited in Prasana 2008) investor's protection is weak when company board is dominated by members of controlling family and it gets difficult to separate the ownership from management then firm value is inversely related to family ownership firms. Their view was supported by Choe, Kho, Stulz (2005) who analysed US investors and concluded that they hold fewer shares in companies where ownership structure is more conducive to insiders. Another observation by LI (2005) was that if there was poor corporate governance then foreign investors tend to prefer other route of Foreign Direct Investment instead as Foreign Institutional Investors. Going further in accessing the information on firm ownership, Leuz, Nanda and Wyoscki (2003) assessed the firm level characteristics and found family control increases insider trading which gives less benefit to foreign investors. They were supported by Haw, Hu, Hwang and Wu (2004) who concluded that firm level characteristics cause information asymmetry problems for FIIs.

In order to analyse the investment preferences of FIIs, Dahlquist et al (2003) analysed the foreign ownership and firm characteristics of Swedish Stock Market and they concluded that FIIs prefer firms which are large, pay low dividends and have a huge cash holdings. Whereas Covirg et al (2007) were of the view that foreign managers have comparatively less information than domestic managers and hence they concern FIIs preference to be based on size of sales and stocks which are listed on foreign soil.

According to Li and Jeong-Bon 2004 (as cited in Prasana 2008), FIIs are in a better position to analyse the public information and hence they tend to avoid stocks with high cross-corporate holdings whereas according to Morin 2000 (as cited in Prasana 2008) as they analysed the French model of shareholding and management of FII pattern concluded that France has undergone a rapid change and has gone away with the traditional system of FII holding and facilitated with new techniques which demands corporate management.

Stock Market Volatility

Research by Forbes and Rigobon (2002), Bekaert, Harvey and Lumsdaine (2002a,b) , Edwards (2000) and others focussed on stock market volatility concentrating on moving of volatilities among different economies and also of the financial crisis which happened thereafter. Bakaert and Harvey 2000 (as cited in Batra 2004) analysed equity returns of a group of emerging markets before and after financial reforms. According to Aggarwal, Inclan and Leal 1999 (as cited in Batra 2004) local events and happenings make the stock markets to turn volatile in emerging economies. In order to draw this conclusion they analysed emerging stock markets for volatility for period of 1985-95 and by using ICSS algorithm they identified points of sudden change when some event occurred or when there was large movement in stock market volatility. They calculated the variance at each point. According to De Santis and Imrohoroglu 1997 (cited in Ranjan Kumar Dash and Sumanjeet Singh) studied the behaviour of volatility in emerging markets and the effect of liberalisation on financial markets and concluded that volatility decreased after liberalisation. Their study was contradicted by Singh (1993), Grabel (1995), Levine and Zervous (1998), Kamminsky and Schmickler (2001 and 2003), Nission (2002) and Edwards et al. 2003 (cited in Ranjan Kumar Dash and Sumanjeet Singh) by saying that financial liberalisation increases stock market volatility. In Indian context, Samal 1997 and Pal 1998 (cited in Ranjan Kumar Dash and Sumanjeet Singh) found that FIIs investment is the major source of volatility whereas stock market volatility was lower in liberalized economy. This view was supported by Richards 1996 who took three different methodologies and two different sets of data to calculate the volatility in emerging markets and came with the conclusion that there was no empirical evidence which supports that liberalization of economy increases volatility in stock markets.

Hamao and Mei 2001(as cited in Batra 2004) examined Japanese market at a time when foreign portfolio investments in Japan were small and found no proper evidence to prove that foreign investments tend to increase volatility more than increase in volatility due to domestic investors. Folkerts - Landau and Ito 1995 (as cited in Batra 2004) computed market volatility in emerging economies at different periods in which there was a difference in flow of portfolio and found in case of Mexico that stock prices were less volatile when Foreign flows were more volatile and vice versa for Hong Kong. According to Nilsson (2002) by using Markov regime switching model in Nordic Stock markets, liberalisation in stock markets leads to increase in volatility. Nilsson also evidenced that higher volatility and higher expected returns have strong links with international stock markets.

Considerable attention has been paid these days to stock market volatility and especially after global recession. Stock Markets had been highly volatile in emerging markets like India and its study becomes important.

Investment strategies of FIIs

There has been a considerable amount of research done on the investment strategies of FIIs which show the Positive feedback and herding strategies being followed by FIIs. Research done by Lakonishok, Shleifer and Vishny (LSV) 1992(cited in Sehgal and Tripathi 2009) looked at the investment behaviour of 769 US tax exempt equity funds managed by 341 money managers for the period of 1985 to 1989. They concluded that there was no herding by money managers but it was prevailing in the behaviour of stock prices of small companies than in large companies. The reason given by LSV is that information on large stocks is easily available whereas small companies do not provide much information to public, so money managers look at the investments by other big investors into small stock and follow them. According to LSV, it is difficult to find the effect of herding as at times a small amount of herding can bring significant movement in stock prices. An argument was put forward by Dornbusch and Park (1995) that foreign investors follow positive feedback strategy which leads to stock unusual movement in stock prices.

Wermers 1998 (cited in Sehgal and Tripathi 2009) used LSV measures to check the presence of herding among mutual funds. He took the quarterly data of mutual funds from 1975 till 1994 and concluded that mutual funds showed existence of herding. He also analysed stocks and concluded that herding among those stocks tend to be higher which had reported higher amounts stock returns in the previous quarter. He concluded that investors buy those stocks which had good returns in the previous quarter and sell those stocks which had poor quarterly results. After computing average level of herding by Wermers model it was concluded that herding is more in mutual funds than in stocks. But after analysis of trading behaviour of large pool of mutual funds it was found that the herding behaviour in fact reduces in mutual funds and it was justified as large pool of mutual funds carry stock which have large amount of capitalisation and companies with large capitalisation tend not to do any herding. Another analysis by Bonser- Neal et al 2002 (cited in Sehgal and Tripathi 2009) analysed the foreign trading behaviour on Jakarta Stock exchange between 1995 and 2000 and found positive feedback trading and herding by foreign investors but they didn't find any evidence indicating destabilising of markets due to foreign investors during Asian crisis. Richards 2002 (cited in Sehgal and Tripathi 2009) used data pertaining to net purchases by foreign investors in six Asian emerging markets over 1999-2001 and found an evidence of positive feedback trading.

According to Kim and Wei (2002) foreign investors who live outside Korea are more likely to indulge in positive feedback trading and herding strategies as compared to their branches and subsidiaries who are living in Korea or any foreign national staying in Korea. According to them this difference in trading behaviour arises due to different kind of processing of information by those living outside Korea than those living inside.


Data and Methodology

Research Methodology and Design

According to Collis and Hussey (2003), Methodology refers to overall approach to research process which includes underpinning of theory, collection of data and analysing it. However the research process adopted depends to a great extent on the approach taken by the researcher. Research design is the general plan of how to go about answering the research question. It gives the logic behind every interpretation. Due to nature of research carried out the prime focus has been on gathering the secondary data which is relevant to analysis being carried out. According to Collis and Hussey (2003), there are two main paradigms of research that is qualitative and quantitative. Qualitative research is followed by those people who have phenomenological bent as it deals with understanding the behaviour of human beings. Therefore it is also known as Phenomenological Paradigm. On the other hand Quantitative research refers to those who relate to positive view of the world and therefore this kind of research is also called as Positivistic Paradigm. Positivistic paradigm is used basically in natural sciences as this approach gathers facts with subjectivity of the nature of research and individual bias.

For the purpose of research both qualitative and quantitative data will form part.

Qualitative Data: this data has been collected by:

  • Studying into the certain days on which markets fluctuated in upside or downside direction to a great extent
  • Studying the changes in regulations by the Securities and Exchange Board of India in relation to foreign institutional investors.
  • Studying the behavior of domestic investors and other factors affecting the market.
  • Studying the basis on which the foreign institutional investors entered Indian Stock Market and there enter and exit strategy and its impact on Indian economy.

Quantitative Data: this data has been collected by:

  • Studying the market capitalization of foreign institutional investors and their cumulative effect on stock market
  • Looking in the growth of number of institutional investors and the share of their investments year on year.

The research onion below in the diagram gives an overview, how to achieve the objectives by using the techniques in each layer of the onion.

In order to carry on with the research each onion of the Research Onion has been peeled systematically so as to get in the right direction. The philosophy adopted for the purpose of research is Positivism philosophy as research has been undertaken mostly from the data already published in journals, articles, previous researches etc. Approach taken by the researcher is mainly inductive as maximum data is qualitative and it has been of utmost importance to cover every aspect of research. Researcher has taken the case study strategy to analyse the data. The Researcher has used Mixed Method research choice in the sense the data collected comprises of both qualitative and quantitative data. The time horizon for research has been longitudinal as this research has been carried on after observing the behaviour of stock markets over a long period of time and on happening of any event.

While carrying out the research it has been kept in mind that the research objectives and the characteristics of the information collected match. In order to analyse the Impact of FIIs on Indian Stock market, a thorough research has been done from different sources which includes RBI and SEBI publications, newspaper articles, journals, previous research done on the topic and also from internet.

For the purpose of our research study we are looking into the data till financial year 2008-09.

Limitations of Study:

This study has been taken during the time when impact of recession has not been fully analysed and its exact nature and impact on the movement of stock markets and Financial Institutional Investors cannot be justified as it is a global recession. So research may miss out some of the implications of recession and may not correlate to impact which FIIs may have during the normal market conditions.

Data has been collected mostly through online source. It was not possible to conduct personnel interviews with top brokers in India due to distance barriers. Hence the findings and analysis has been derived on the basis of data available online.

Summary of Research:

The majority of this research is conducted by making use of secondary sources of data which includes journals, articles, books, magazines, newspapers, Internet and other electronic sources. The research in this area has already been conducted but the purpose of this research is to generate new ideas and to gain further understanding into the subject by looking into each and every detail of it. This research is conducted at the time of recession, the condition which was not prevalent earlier, so it is expected to bring new concepts and theories into existent and it will also over rule some of the studies that have already been conducted.


Analysis of Indian Stock Market

Overview of Indian Stock Market

Stock markets were first introduced to India in 1875 as a non profit making organisation. Bombay Stock exchange is the oldest stock market in whole Asia. Stocks in India are traded on the stock exchanges which are around 23 which includes Bombay Stock Exchange and National Stock Exchange. Stock exchange is a corporation which provides its brokers to trade stocks of companies which are listed with them. The organisation of Stock Exchange, its systems and practices are regulated by Securities Contract, (Regulation) Act (SC(R) ACT), 1956.They are highly efficient organisations which have led to growth of securities market. Stock exchanges trade securities which include shares, unit trust, pooled investments and also bonds which are listed on them. Members of the stock exchange act as its agents as they are only allowed to trade on behalf of their customers who pay brokerage to them for the services provided by them. Stock exchanges also provide plenty of services as in issuing and redeeming shares and also in payment of dividends to its shareholders through its participants or members.

Stock exchanges are important even though it is not necessary to issue shares via stock exchange. Shares are normally issued through Initial Public Offering (IPO). Stock exchanges play a major role in the economy as of today as they help with expansion plans of the country by mobilising the savings to investments and also by redistributing wealth among the economy.

Stock exchanges maintains the records of all the shareholders at one central location but shares that are traded on stock exchange they are not dependent on that central location as the computerisation has made it easier to trade stocks. All stock exchanges have become an important part of world market for securities as global investors can invest in any market from anywhere.

Importance of Stock Markets in India:

Stock markets play an important role in the economy as they are now the financial indicators of growth in any country. They represent the crux of functioning of all the sectors of country. NSE NIFTY comprises of 50 top Indian companies from each sector and BSE SENSEX comprises of 30 companies from all the sectors. The following points describe the role stock markets play in India:

  1. Improving Corporate Governance: Since Stock markets are regulated by SEBI, companies are bound to follow the rules and regulations in order to have a good market value of their stocks on stock markets. This is possible only if they keep their shareholders satisfied. So they generally tend to improve their company procedures and management standards to keep up with other companies. They make their financial performance and other important company decision available to its shareholders and also take all necessary steps to make their company fundamentally strong in order to attract foreign investment.
  2. Diversification of Investment opportunities: Everybody wants to have their wealth increased and in order to do so they need to invest in places where they think is most profitable. Take for example small investors; If an investor wants to invest its money into real estate as their is expected to be a boom in that sector but he doesn't have large sum of money to invest in property, so in order to take advantage of opportunity, instead of really investing into property which he cannot afford he can invest in company dealing in real estate sector through stock market. This way he can have the advantage of boom in the sector with his investment and he will also have the opportunity to invest in any other sector which he thinks is profitable.
  3. Mobilising Savings: People earn money and then they save it for their future but this approach is not favourable for the growth of the economy of any country. So savings needs to be mobilised and converted them into investments to have a growing economy. Stock markets have created a good platform for investors to invest money as they can invest or withdraw anytime they want. Indian investors which include small investors as well as domestic and foreign institutional investors have seen a growth in number of investors over the years. This has helped India to mobilise investments in under developed sectors and have a balanced growth.
  4. Redistribution of Wealth: By investing in different stocks, stock markets give chance to its investors to become part of the different companies and help them to make profits in their stocks and have a systematic growth in their money. This helps in money flow and helps in reducing inequalities of income. This way income gets distributed among wide spectrum of investors and it helps in improving standard of living of different investors by redistributing wealth.
  5. Raising of Money by Corporate and Government: In order to go ahead with the expansion, the big corporate and even the government needs money. In order to go for large scale expansion it is not sensible to invest all the money from your own pocket. So in order to reduce the risk, big corporate and Governments divide the risk by raising money from public. Public basically are investors who want to be part of the expansion plans lend money to these corporate and government and expect return on their investments. Companies come up with IPO and government may issue bonds. These investments don't have any fixed obligations to pay but they tend to pay returns to its investors. Stock markets facilitate issuance of IPO and bonds and helps companies and government in raising money. Investors then become the shareholders of the company and have right to participate in the decision making of the company as they have right to vote. SEBI protects the right of these investors and avoid any discrepancies from happening.
  6. Barometer of Economy: Stock markets are the mirror of any economy. They represent the country in terms of its progress and its economic outlook. If the stock markets are volatile then the foreign investors tend to stay away from the markets but if the stock markets are stable in their performance and fundamentals of the company are strong, foreign investors tend to flush the money in economy and help in keep a positive balance of payments. Economic stability also helps in getting the currency strong against other countries. Indian companies are based on strong fundamentals and stock market looks positive and hence foreign investors are eyeing Indian stock market with top preference among all the emerging economies.


Analysis of Foreign Institutional Investors

Foreign Institutional Investors:

Foreign Institutional investors are those investors which are registered with Securities and Exchange Board of India to participate in the market. This term is basically used in context to India and it refers to those institutions or organisations which invests their money into financial market of India. These organisations are incorporated in countries outside India and they may include:

  • Hedge Funds
  • Pension Funds
  • Mutual Funds
  • Insurance companies
  • Investment trusts
  • Banks
  • Endowments
  • Foundations
  • University Funds
  • Charitable Trusts

Following entries proposed to invest on behalf of broad based funds, are also eligible to be registered as FIIs:

  • Asset Management Companies
  • Institutional Portfolio Managers
  • Trustees
  • Power of Attorney Holders


  1. Eligibility Criteria for deciding FIIs Application by SEBI
    1. Applicant's track record, professional competence, financial soundness, experience, general reputation of fairness and integrity.
    2. The applicant should be registered and regulated by appropriate Foreign Regulatory Authority in the same capacity in which application is filed with SEBI
    3. The applicant should be fit and proper person
    4. The applicant should have been in existence for past one year.

    In order to invest in Indian Stock markets, FIIs have to abide by rules and regulations imposed by SEBI. FIIs have to register themselves with SEBI. Registration process takes seven working days and these days start from the day FIIs give complete documents to SEBI for registration with registration fees of US $5000.

  2. Financial Instruments Applicable to FIIs
  3. The financial instruments applicable to FIIs are:

    1. Securities in primary and secondary markets which includes shares, debentures, warrants of companies, listed companies, unlisted companies or companies in the process of listing.
    2. Units of Mutual Funds
    3. Dated Government Securities
    4. Derivatives traded on a recognized stock exchange
    5. Commercial papers
  4. Regulations for Foreign Investors:
  5. Foreign Institutional Investors, Persons of Indian Origin and Non-Resident Indians are allowed to invest in Indian stock market through Portfolio Investment Scheme to acquire an interest in Indian companies through Stock exchange on the following basis:

    • FIIs can invest in Indian company up to 24% of the paid up capital of the company. This limit can be enhanced to statutory ceiling limit of the company if a special resolution is passed by the board of directors and the general body of the company.
    • NRIs and PIOs can invest in Indian company to the limit of 10% of the paid up capital of the company. This limit can be increased to 24% by passing a resolution subject to approval of general body of the company.
    • There is no co-relation between the ceiling limit of FII and NRI or PIO.
    • The limit mentioned above is the overall limit of FIIs/NRIs/PIOs regardless of number of FIIs/NRIs/PIOs


Now since these limits have been sanctioned to foreign investors, it is necessary to monitor these limits. These limits are monitored by Reserve Bank of India by putting a cut of 2% lower than their actual investments limits. So when these investments reach their cut off limit, RBI informs the banks who make investments on the behalf of foreign investors to stop any further buying for them. If they need to buy further they need to take permission from RBI which gives permission on first come first basis. This step by RBI helps to curb excessive control by foreign investors and hence tries to avoid excess volatility in stock market. In order to safeguard investors RBI notifies investors to stop buying in these companies in order to reduce the risks associated with investing in these companies.


Foreign Institutional Investors have become a part of important mechanism for the growth of any country as they mobilise savings and convert them to investments and since the cost of capital of these investments is low, they are most efficient mode of investments. These investors by increasing their investments help in strengthening the currency of the country and economic prosperity of the country. These investors have changed the Indian stock market by bringing in qualitative and quantitative changes as they have increased the breadth and depth of market. They focus on fundamental of shares and lead to efficient pricing of the shares and hence they play an important role in the growth of stock market. These FIIs function by bringing in the money from the economies where borrowing costs in lower and by investing in economies which are growing. These FIIs have such an impact on the economy that their movement affects the movement of stocks on the stock market in such a way that if they flush money into stock market, markets rise and if they withdraw money then the markets fall miserably. Government is making loads of effort to attract these investors to Indian economy as they have realised the importance of these investments.

The major portion of investments by foreign institutional investors goes to equity market impacting the shareholding pattern of the companies listed on the Indian Stock exchanges. Nearly ninety-five percent of their investments contribute to key indices and nearly half of their investment is into top five companies listed on the stock exchange and therefore having a large effect on the performance of the Indian Stock market.

Securities and Exchange Board of India (SEBI)

The Securities and Exchange Board of India was established on 12th April 1988 as a non statutory body in order to deal with matters related to development and regulation of securities market, investor protection and to advise government on all the matters. ( It became an independent body in 1992 when it was given more powers.

  1. Objectives of SEBI
    • The main objective of SEBI is to look after the interest of the investors, so that they don't suffer due to any irregularities of the companies.
    • Another objective of SEBI is to constantly involve with regulating and developing of its securities market so that it becomes easier for its investors to trade on it and for issuers of securities by simplification of its processes.

    In order to achieve these objectives SEBI has introduced regulatory measures, code of conduct for its participants, limits of their involvement, financial obligation which its participants may have to incur in case of deviation from their course of action and it has also taken steps to stop manipulations in order to make it convenient for investors to invest by making all the procedures transparent.

  2. Functions of SEBI
  3. According to Section 11 of the Securities and Exchange Board of India Act, functions of SEBI are:

    1. To regulate the businesses of Stock Exchanges by reviewing their market operations and having an administrative control over the exchange.
    2. To register and regulate the working of its depository participants, foreign institutional investors and other intermediaries.
    3. To curb any unfair trade practices and fraud happening in the securities market by taking necessary steps and strict actions to have a normal functioning of securities market.
    4. To prohibit insider trading by strengthening the market surveillance.
    5. To educate its investors by giving them training and also by keeping them updated about the recent developments happening in the securities market by issuance of its journal and publications and by other press releases.

Government Initiative:

Initially FIIs restricted themselves from entering into Indian as there were many terms and conditions to invest in India. But slowly and steadily SEBI simplified the norms for FIIs to enter into Indian market by taking various steps:

  • SEBI increased the ceiling of investments of FIIs to 24% of the paid up capital of the company or up to the statutory limit of the company subject to approval by the company.
  • They allowed foreign individuals to directly register as FIIs by simplifying registration norms. They also simplified norms for opening of Sub-accounts.
  • FIIs are allowed to invest in Indian primary and secondary market through portfolio investment scheme which allows them to acquire shares and debentures of Indian companies.
  • SEBI increased the limit of FIIs investment in corporate bonds to US$ 15 billion.
  • SEBI increased the limit of FIIs in Government securities to US$ 5 billion.
  • SEBI allowed FIIs to invest in equities or debts in any ratio they want. This step was taken to allow flexibility to foreign investors to decide them to invest in any instrument they want.
  • SEBI reduced the brokerage' paid by FIIs to attract them to invest in India by giving them cost saving advantage.
  • SEBI also allowed Institutional portfolio managers and other investment managers belonging to NRI category to register themselves as FIIs.
  • SEBI lifted ban on 40% limit on investments through Participatory Notes.



Findings and Analysis

Investment climate in India:

India has been facing the financial crisis since the time it attained independence. The turnaround for Indian economy came after balance of payment crisis which led to opening up of Indian economy for foreign investors as India got support from International Monetary Fund. These crisis led India to growth process as India went on towards the globalisation as reforms were introduced to make the country conducive to free flow of resources from one country to other. Government took steps to promote Indian investors to open up for foreign know how and technical support.

Foreign Investors came to India in two forms; firstly as Foreign Direct Investors and Secondly as Foreign Institutional Investors. Though both these investors bring money into Indian Economy but there is difference between the two. Foreign Direct Investors invest in different sectors irrespective of its share price. They are basically the long term investors as they develop the different resources in the country. Foreign Institutional Investors are in country for short period of time, they invest in company and withdraw as soon as they get profits and then invest in any other company. Indian government is keen on attracting Foreign Direct Investors to country because they affect the long term growth of the country. But country needs both the Investors. Foreign Institutional Investors provide liquidity to economy.

India realized the importance of Foreign Investors after the crisis as they knew that domestic investments will be insufficient to put the country into growth path. Since then the investment climate in India has been very positive. India has been able to achieve GDP growth of 8% and has brought down the inflation costs. India has loads of resources ready to be unleashed just waiting for the right opportunity. The low costs of investment and labour has brought the country on a high platform. The best thing about India is that it not only has huge supply but it also has huge demand. So it can be said that India has a positive investment climate with long term story which foreign investors are aware.

Present Investment Scenario:

The worst year in the history of Indian Stock Market has been 2008 in which the markets crashed from High of 21000 points to low of 9000 points. According to SEBI, foreign institutional investors from March till November 2008 were net sellers to the extent of US$ 8 billion whereas in the same period a year before they were net investors to the extent of US $ 16billion, nearly double in the previous year in the same period. This was mainly due to global recession and also Satyam Computers Ltd's corporate governance issue. Despite these Indian economy is booming and has been attracting investments by FIIs. This has been possible due to constant effort by SEBI by promoting the financial market of India and by taking measures such as relaxing the measures for FIIs to enter in India and by other measures inducing investments.

According to data given by Securities and Exchange board of India as on 17th March 2009, total number of FIIs registered with SEBI equals 1626 and registered sub-accounts equals 4972 and their cumulative investments in equity market stands at US$ 50950.20 million and Investments in Debts stand at US$ 6541.50 million. This amount is nearly 25% of the total investments by FIIs coming into Asia, Africa and Latin America which was around 15% in 2007. According to US global management based consulting firm A T Kearney, India is the most attractive destination among the top 30 emerging economies of the world. India has been ranked as most attractive destination for foreign investors in retail segment for the fourth time in five years.

Foreign Institutional Investors have invested in Indian economy in the month of May the amount equals to US$ 4.17 billion in equity which is highest in past one and half year. There are loads of new financial institutional investors entering the market despite the global meltdown which includes Morgan Stanley, HSBC, Goldman Sachs, etc. These all are the big investors who have global recognition.

Some instances of recent deals by some of the big investors explains the story of continued growth of Indian Economy:

  • Kotak Mahindra's purchase of stakes in NIIT in March'09 for over US$ 897414.
  • Goldman Sachs purchased stake in NDTV to the extent of 8.16%
  • Morgan Stanley purchased stake in IDFC to the value of US$ 11.61 million.
  • HSBC bought shares of Intellivisons for US$144.94 billion.

These are just few from many foreign investments which entered in 2009.

Due to increase in these investments, the results for quarter ending June 2009 have been encouraging. According to Prateek Agrawal, Head-Equity, Bharti Investment Managers out of 30 BSE Sensex companies 25 of them have reported that their earnings are flat which is good as compared to predictions by analysts to be falling as an impact of recession. The Earnings Before Interest Tax and Depreciation are also up by 5.9% for the overall market. There has been a volatile market overall but the sector-wise growth has been stagnant

Net Flows are Gross Purchases by FIIs minus Gross Sales by FIIs. In other words, Net flow is equal to inflows minus outflows.

Looking at above it can be seen that Net flows by FIIs have been positive for the whole year of 2007 except in the months of August and November. But 2008 gave a bad start with FII flows going into negative which means that FIIs withdrew money from Indian market and they had been a net seller for nearly Rs 18000 Crores. They turned positive in February, March and April then went into negative again all the way down till end of November 2008. This period had been the worst period in the history of Indian Stock Market as markets fell miserably. But the effect of recession impacted Indian Economy badly till February 2009 but after that things started to turnaround and FIIs turned out to be net buyers again in Indian Stock Market. They invested nearly Rs 21000 crores in the month of May 2009. The main reason for rise in investment by FIIs in the month of May has been due to formation of UPA led government with full majority which gave a boost towards market sentiment as government will be able to go ahead with its plans of progress which they were not able to do during last regime due to coalition government formed with minority support. By investing in Indian stock markets just after the elections results, FIIs had shown their support to UPA Government. Hence it can be said that India is still a favourite destination by FIIs for investment.

Now let us have a look at the growth factors of India till last year.

Indian stock market had slowdown in 2008 after four years of strong gains in the market. Indian market had been growing due to positive flows by FIIs and development in other sectors due to development by FDIs. But due to sub-prime recession, FIIs had started pulling money back from Indian market due to bad position of FIIs in their own country. This led to fall in Indian stock market which created panic among Indian investors. One of the indicators of economic growth of country is Gross Domestic Production (GDP).

After looking at the GDP growth of India year-on-year, it looks promising even though it slipped down a bit in 2001 and 2002. This improvement in GDP has been ringing bells in the foreign investors and they are investing in India as the long term story of India looks good with its strong fundamentals. GDP has also been high due to FDI in Indian economy and also due to self sufficiency of Indian economy in agricultural and manufacturing goods. Due to this self sufficiency exports of these goods leads to improvement in foreign currency and makes our currency strong against other currencies.

Now let us have a look at above table and figure to analyse biggest intraday falls in past three years. On 18/5/06, Sensex lost 856 points and Gross purchases of FIIs were Rs 761.80 crores and Gross Sales were Rs 527.40 crores finally leading to net positive investment of Rs 234.40 crores. If we look at it any layman would think that since FIIs purchased more that is why markets crashed. But the one who deals in stocks and has knowledge about workings of stock market will realize that since markets fell, FIIs did loads of buying to take advantage of the fall. Here markets didn't fall due to FIIs involvement instead FIIs took advantage of the situation. Now let us look at other date which is 1/8/07 on which market crashed by 615 points. On analysis it can be seen that FIIs were net sellers to Rs 147.50 crores. Though markets crashed by less points as compared to previous day but FIIs were net sellers. The reason behind is that markets crashed because FIIs withdrew money. FIIs short selling created panic among the market and market crashed. Now let us look at the biggest crash which was on 21st Jan 2008. Sensex crashed by 1408 points and still FIIs were net buyers to Rs 2001.80 crores. This crash was triggered due to weakness in global markets but it impacted India the most as compared to other world markets. FIIs took advantage of it and did buying.

So now after looking above it can be seen that FIIs take advantage of each and every situation that arises. They invest when the markets crash and they also lead to crash in markets when they withdraw. They have a great impact this way on the stocks. They always take benefit out of it. If a close watch is kept on FIIs by investors, they can take advantage of the movement of FIIs and have gains from stock market investments and reduce their risks as FIIs have strong network, highly capable staff and they do proper research before investing and they generally invest in Index stocks which represents the whole sectors.

In Figure 8 above Monthly Trends has been shown of Investments made by FIIs in Indian Stock Market. This trend has been shown from the period of January 2008 till April 2009. This period is of significance to our study as January 2008 has been the time when impact of global recession started showing signs on Indian economy and it is shown till April 2009 as signs of recession had started to be slowed down with the economic development and measures taken by the Government. Above gross purchases, gross sales and net purchases/sales by FIIs in equity and debt market has been shown. As it can be seen that investments by FIIs had been negative in equities during most of 2008 except for few months and this effect continued on till February 2009 and after that FIIs had started pouring money back into economy due to strong fundamentals of economy. As regards to Investments in Debt market is concerned FIIs had been net investors in most of the months except few months as Debt carries a fixed rate of return and is there for a fixed period of time. During the month of February and March 2009 FIIs were net sellers in Debt securities and the reason behind was that Indian economy was back on its path of growth and in a growing economy returns a more in equity investments then in Debt investments, so there is a probability that the after selling the debt instruments the investments were flushed into equity market and it can be seen from above that equity markets were flushed by FII investment during March and April 2009.

From above following analysis can be drawn:

  • Due to global recession FII flows into India might have slowed down a bit but long term story is good. Markets have fallen down from high of Sensex 21000 points to 8000 points but it is slowly and steadily picking up. So it is a good time to invest into Indian Market.
  • Indian economy is driven by domestic consumption and investment and hence the effect of global recession has not impacted it as bad as to other countries.
  • People of India have been concentrating on saving their money and hence savings are high and hence the long term economic growth of country looks certain.
  • Due to rise in inflation there was a marginal pressure on the resources of the country but this had been due to rise in crude oil prices and hence this was affecting the foreign currency reserves of country. According to Centre for Monitoring Indian Economy (CMIE) for the financial year 2009-10 has been down to 0.3% as compared to 2008-09 which was around 8.3%. (
  • After looking at the fundamentals of growth of Indian economy, FIIs which had turned out to be net sellers in 2008 are entering back strongly into Indian economy which is evidenced after looking at the growth in the number of FIIs registered till first half of 2009 which increased from last year. There are loads of new FIIs entering into Indian Economy which is also due to Government's efforts by giving certain relaxations to FIIs and making procedures for them to enter to India easy.
  • Due to volatility in stock markets in recent past, there have been many new opportunities coming up for investors in India as stock markets are at low and its good time to invest.
  • The main driver for FIIs has been the corporate governance of Indian companies which is creating strong fundamentals for portfolio stocks.
  • As of today stock valuations are attractive as Indian economy is on a low as compared to last year. Hence it is a good opportunity to invest but investments in stocks has to be done after careful analysis. Even though FIIs before investing in any stock do the background research about the company but before making a decision as a investor it becomes our duty to do our research as well in order to minimise the risks associated with following FIIs blindly.
  • The subprime crisis in US had not affected India to large extent but it sent shockwaves among Indian investors and as a result in year 2008 Indian stock Market had to see one of its greatest falls which was mainly led by withdrawing of money by FIIs. This made Indian investors scared to invest in stock markets but the thing to note here is that investors forget it that markets will not always move in upward direction. Even though increasing participation of FIIs has increased volatility in the stock markets but Indian markets are fundamentally strong so prices may fall for time being but in long run they will rise.



One of the most significant factors in the growth of Indian economy has been foreign investments. India has been the most favourite destination for investors from all over the world and every year the total number of foreign investors getting registered with SEBI are increasing significantly. The growth of Indian economy is on one hand due to the strong fundamentals of Indian companies and on the other hand due to liberalisations of financial reforms which led to entry of foreign investors. So contribution of Foreign Investors can't be ignored in the growth of Indian economy.

On one side FIIs have brought growth to country and on the other hand side they have brought volatility to stock markets. They have a significant control on the movement of stock prices as when FIIs invest prices go up and when they withdraw prices go down. It is visible that the there is a direct relationship between movement of stock market and FIIs flow into Indian economy. FIIs withdrawal of investments from the markets leads to fall in stock market and also FIIs invest at the time when markets fall and then prices tend to move upwards.

FIIs have brought transparency in the procedures, automation and regulations regarding disclosure and reporting standards for companies and have brought corporate governance at its best. They have brought Indian Stock Market in standards with International standards by bringing in Automation and screen based trading system to Indian Stock Market. They have also brought in higher level of accountability for the companies and improved their standards of performance. The volume of investments by FIIs is not very high but they tend to drive the sentiment of the market as other investors tend to follow them. This kind of behaviour by other investors is due to FIIs being considered as a large reservoir of information and the basic aim behind their investment is to make profit and leave the company. FIIs tend to invest in companies which have strong potential and have huge financial backing and good public standing. They consider many factors before making their investments in any company which includes the transparency of companies, less involvement of any majority shareholder, it should not be family run business and should have huge market capitalisation. So basically they tend to be very cautious in decision making before investing, so domestic investors tend to have the herding behaviour and follow FIIs.

Results of this research also show that FIIs are the most dominant shareholder on the stock market. After looking at their shareholding pattern it can be said that the holdings of FIIs is the highest after promoters and hence they are able to decide the direction of the market. RBI has been trying to place limits on the number of shares being bought by FIIs in order to make stock market independent of FIIs and on the other hand side government is bound to be lenient with FIIs as any disinvestment by FIIs brings a huge fall in stock markets and creates a situation of panic among investors and market sentiment turns negative. This can be seen from the example in the past when RBI placed a ban on entry route for FIIs through participatory notes in Indian Stock Markets, there was a huge fall in stock market as FIIs started to sell their shares and market sentiment became negative, so RBI had to come up again to reverse its policy, in order to create normalcy in market.

Another major impact is that FIIs tend to manipulate the prices of stock as in when they enter they take the prices of stock very high and people follow them in buying and suddenly when people are still buying at high prices they tend to sell and small investor gets stuck up with the share at high price. They act as speculators instead of investors as they invest in stocks for short term and after attaining short term gains they tend to move to another company. FIIs move their investments regularly and because of these swings there is a tendency of volatility in the market. There has also been evidence that FIIs tend to manipulate the prices of stock by correlating with few of the big brokers and get involved into insider trading which is considered to be bad prac