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Impact of FIIs on Indian Stock Market for a period of 2006 2009

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Published: Mon, 5 Dec 2016

Indian economy has been witnessing a phenomenal growth since the last decade. The country is still holding its ground in the midst of the current global financial crisis. In fact, global investment firm, Moody’s, says that driven by renewed growth in India and China, the world economy is beginning to recover from the one of the worst economic downturns in decades.

The growth in real Gross Domestic Product at factor cost stood at 6.7 % in 2008-09. While the sector-wise growth of GDP in agriculture, forestry and fishing was at 1.6 % in 2008-09, industry witnessed growth to 3.9 % of the GDP in 2008-09.

The Prime Minister, Dr Manmohan Singh, on August 15, 2009, in his address to the nation on its 63rd Independence Day, said that the Government will take every possible step to restore annual economic growth to 9 %.

Further, the World Bank has projected an 8 % growth for India in 2010, which will make it the fastest-growing economy for the first time, overtaking China’s expected 7.7 % growth.

A number of leading indicators, such as increase in hiring, freight movement at major ports and encouraging data from a number of key manufacturing segments, such as steel and cement, indicate that the downturn has bottomed out and highlight the Indian economy’s resilience. Recent indicators from leading indices, such as Nomura’s Composite Leading Index (CLI), UBS’ Lead Economic Indicator (LEI) and ABN Amro’ Purchasing Managers’ Index (PMI), too bear out this optimism in the Indian economy.

Industrial output as measured by the index of industrial production (IIP) clocked an annual growth rate of 6.8 % in July 2009, according to the Central Statistical Organisation.

Significantly, among the major economies in the Asia-Pacific region, India’s private domestic consumption as share of GDP, at 57 % in 2008, was the highest, according to an analysis by the McKinsey Global Institute.

Meanwhile, foreign institutional investors (FIIs) turned net buyers in the Indian market in 2009. FIIs inflows into the Indian equity markets have touched US$ 10 billion in the April to September period of 2009-10.

Foreign direct investments (FDI) into India went up from US$ 25.1 billion in 2007 to US$ 46.5 Indian economy has been witnessing a phenomenal growth since the last decade. The country is still holding its ground in the midst of the current global financial crisis. In fact, global investment firm, Moody’s, says that driven by renewed growth in India and China, the world economy is beginning to recover from the one of the worst economic downturns in decades.

The growth in real Gross Domestic Product (GDP) at factor cost stood at 6.7 % in 2008-09. While the sector-wise growth of GDP in agriculture, forestry and fishing was at 1.6 % in 2008-09, industry witnessed growth to 3.9 % of the GDP in 2008-09.

The Prime Minister, , on August 15, 2009, in his address to the nation on its 63rd Independence Day, said that the Government will take every possible step to restore annual economic growth to 9 %.

Further, the World Bank has projected an 8 % growth for India in 2010, which will make it the fastest-growing economy for the first time; overtaking China’s expected 7.7 % growth.

A number of leading indicators, such as increase in hiring, freight movement at major ports and encouraging data from a number of key manufacturing segments, such as steel and cement, indicate that the downturn has bottomed out and highlight the Indian economy’s resilience. Recent indicators from leading indices, such as Nomura’s Composite Leading Index (CLI), UBS’ Lead Economic Indicator (LEI) and ABN Amro’ Purchasing Managers’ Index (PMI), too bear out this optimism in the Indian economy.

Industrial output as measured by the index of industrial production (IIP) clocked an annual growth rate of 6.8 % in July 2009, according to the Central Statistical Organization.

Significantly, among the major economies in the Asia-Pacific region, India’s private domestic consumption as share of GDP, at 57 % in 2008, was the highest, according to an analysis by the McKinsey Global Institute.

Meanwhile, foreign institutional investors (FIIs) turned net buyers in the Indian market in 2009. FIIs inflows into the Indian equity markets have touched US$ 10 billion in the April to September period of 2009-10.

Foreign direct investments (FDI) into India went up from US$ 25.1 billion in 2007 to US$ 46.5 billion in 2008, achieving a 85.1 % growth in FDI flows, the highest across countries, according to a recent study by the United Nations Conference on Trade & Development (UNCTAD).

According to the Asian Development Bank’s (ADB) ‘Asia Capital Markets Monitor’ report, the Indian equity market has emerged as the third biggest after China and Hong Kong in the emerging Asian region, with a market capitalization of nearly US$ 600 billion.

The Economic scenario

Indian investors have emerged as the most optimistic group in Asia, according to the Quarterly Investor Dashboard Sentiment survey by global financial services group, ING. As per the survey, around 84 % of the Indian respondents expect the stock market to rise in the third quarter of 2009.

With foreign assets growing by more than 100 per cent annually in recent years, Indian multinational enterprises (MNEs) have become significant investors in global business markets and India is rapidly staking a claim to being a true global business power, according to a survey by the Indian School of Business and the Vale Columbia Center on Sustainable International Investment.

In its optimistic report on Macroeconomic and Monetary Development of the economy in 2009, the Reserve Bank of India (RBI) said overall business sentiment was slated for a sharp improvement from that in the April-June 2009 quarter.

Further, India and China will soon emerge as the preferred destinations for foreign investors, revealed Economy.com, the research arm of global rating agency Moody’s.

  • The country’s foreign exchange reserves rose by US$ 1.28 billion to touch US$ 277.64 billion for the week ended September 4, 2009, according to figures released in the RBI’s Weekly Statistical Supplement.
  • Net inflows through various non-resident Indians (NRIs) deposits surged from US$ 179 million in 2007-08 to US$ 3,999 million in 2008-09, according to the RBI. The most recent World Bank update on migration and remittances reveals that the remittances of US$ 52 billion by overseas Indians in 2008 makes it India’s largest source of foreign exchange. India, along with China and Mexico, retained its position as one of the top recipients of migrant remittances among developing countries in 2008.
  • FDI inflows into India in April-May 2009-10 have surged by 13 % at US$ 4.2 billion as against the previous two months driven by recovery in the global financial markets. Cumulative FDI in India from April 2000 to March 2009 stood at about US$ 90 billion.
  • FIIs inflows into the Indian equity markets have touched US$ 10 billion in the April to September period of 2009-10.
  • Venture Capital firms invested US$ 117 million over 27 deals in India during the six months ending June 2009, according to a study by Venture Intelligence in partnership with the Global-India Venture Capital Association.
  • The private equity (PE) investment into the country reached US$ 1.03 billion during April-June 2009-registering an increase of 17 % sequentially-according to data compiled by SMC Capitals, an equity research and analysis firm.
  • The year-on-year (y-o-y) aggregate bank deposits stood at 21.2 per cent as on January 2, 2009. Bank credit touched 24 % (y-o-y) on January 2, 2009, as against 21.4 % on January 4, 2008.
  • Since October 2008, the RBI has cut the cash reserve ratio (CRR) and the repo rate by 400 basis points each. Also, the reverse repo rate has been lowered by 200 basis points. Till April 7, 2009, the CRR had further been lowered by 50 basis points, while the repo and reverse repo rates have been lowered by 150 basis points each.
  • Exports from special economic zones (SEZs) rose 33 per cent during the year to end-March 2009. Exports from such tax-free manufacturing hubs totalled US$ 18.16 billion last year up from US$ 13.60 billion a year before.
  • India Inc’s order book has more than doubled to an all-time high of US$ 15.32 billion in the second quarter of the current financial year, compared to the first quarter. On a year-on-year basis, the increase is 21 per cent.
  • Advance tax collections for the second quarter of the current financial year (2009-10) have shown robust growth of 35 to 40 per cent across industries.
  • The domestic mutual fund industry registered a moderate growth of 5 per cent in its assets under management (AUM) in August 2009 at US$ 15,702, due to good performance by debt funds.
  • India exported a total of 230,000 cars, vans, sport utility vehicles (SUVs) and trucks between January and July 2009, a growth of 18 per cent owing to its liberal investment policies and high quality manufacturing that stems from its growing prowess in research and development.
  • India’s gems and jewellery exports regained momentum and aggregated to US$ 1.9 billion in July 2009 as compared to US$ 1.7 billion in June 2009.
  • The total Merger and acquisition (M&A) deals registered during the first seven months of this year stand at 158 with a value of US$ 5.91 billion, while PE deals stand at 114, totalling a value of US$ 4.89 billion, according to consulting firm, Grant Thornton
  • Investments in the Indian stock market through participatory notes (PNs) crossed US$ 20.65 billion-mark in May 2009.
  • Sustainable energy investment in India went up to US$ 3.7 billion in 2008, up 12 per cent since 2007, according a report titled ‘Global Trends in Sustainable Energy Investment 2009’.

The rural India growth story

The Indian growth story is spreading to the rural and semi-urban areas as well. The next phase of growth is expected to come from rural markets with rural India accounting for almost half of the domestic retail market, valued over US$ 300 billion. Rural India is set to witness an economic boom, with per capita income having grown by 50 per cent over the last 10 years, mainly on account of rising commodity prices and improved productivity. Development of basic infrastructure, generation of employment guarantee schemes, better information services and access to funding are also bringing prosperity to rural households.

Per Capita Income

Per capita income of Indian individuals stood at US$ 773.54 in 2008-09, according to Central Statistical Organization data. The per capita income in India stood at US$ 687.03 in 2007-08 and has risen by over one-third from US$ 536.79 in 2005-06 to US$ 773.54 in 2008-09.

Advantage India

  • According to the World Fact Book, India is among the world’s youngest nations with a median age of 25 years as compared to 43 in Japan and 36 in USA. Of the BRIC-Brazil, Russia, India and China-countries, India is projected to stay the youngest with its working-age population estimated to rise to 70 % of the total demographic by 2030, the largest in the world. India will see 70 million new entrants to its workforce over the next 5 years.
  • India has the second largest area of arable land in the world, making it one of the world’s largest food producers-over 200 million tonnes of foodgrains are produced annually. India is the world’s largest producer of milk (100 million tonnes per annum), sugarcane (315 million tonnes per annum) and tea (930 million kg per annum) and the second largest producer of rice, fruit and vegetables.
  • With the largest number of listed companies – 10,000 across 23 stock exchanges, India has the third largest investor base in the world.
  • India’s healthy banking system with a network of 70,000 branches is among the largest in the world.
  • According to a study by the McKinsey Global Institute (MGI), India’s consumer market will be the world’s fifth largest (from twelfth) in the world by 2025 and India’s middle class will swell by over ten times from its current size of 50 million to 583 million people by 2025.
  • India, which recorded production of 22.14 million tonne of steel during April-August 2009, is likely to emerge as the world’s third largest steel producer in the current year.
  • India continues to be the most preferred destination-among 50 top countries-for companies looking to offshore their information technology (IT) and back-office functions, according to global management consultancy, AT Kearney.
  • The Indian stock markets have risen to be amongst the best performers globally across the emerging and developed markets in 2009 year-to-date, according to an analytical study by MSCI Barra indices.
  • India has reclaimed its position as the most attractive destination for global retailers despite the downturn, according to the Global Retail Development Index (GRDI) brought out by US-based global management consulting firm, A T Kearney.

Growth potential

  • According to the Young report titled ‘India 2012: Telecom growth continues,’ India’s telecom services industry revenues are projected to reach US$ 54 billion in 2012, up from US$ 31 billion in 2008. The Indian telecom industry registered the highest number of subscriber additions at 15.84 million in March 2009, setting a global record.
  • A McKinsey report, ‘The rise of Indian Consumer Market’, estimates that the Indian consumer market is likely to grow four times by 2025, which is currently valued at US$ 511 billion.
  • India ranks among the top 12 producers of manufacturing value added (MVA)-witnessing an increase of 12.3 % in its MVA output in 2005-2007 as against 6.9 % in 2000-2005-according to the United Nations Industrial Development Organization (UNIDO).
  • In textiles, the country is ranked 4th, while in electrical machinery & apparatus it is ranked fifth. It holds 6th position in the basic metals category; seventh in chemicals and chemical products; 10th in leather, leather products, refined petroleum products & nuclear fuel; twelfth in machinery and equipment & motor vehicles.
  • In a development slated to enhance India’s macroeconomic health as well as energy security, Reliance Industries has commenced natural gas production from its D-6 block in the Krishna-Godavari (KG) basin.
  • India has a market value of US$ 270.98 billion in low-carbon and environmental goods & services (LCEGS). With a 6 % share of the US$ 4.32 trillion global market, the country is tied with Japan at the third position.
  • PE players are planning to raise funds for the infrastructure sector. Presently, around US$ 1.42 billion is being raised by India-dedicated infrastructure funds, according to data released by Preqin, a global firm that tracks PE and alternative assets.
  • Infrastructure, including roads, power, highways, airports, ports and railways, has emerged as an asset class with long-term growth that can provide relatively stable returns.
  • NASSCOM has estimated that the IT-BPO industry will witness an export growth of 4-7 % and domestic market growth of 15-18 % in 2009-10. Further, it has projected that around 40,000 students will be absorbed by IT companies this fiscal.

With the availability of the 3G spectrum, about 275 million Indian subscribers will use 3G-enabled services, and the number of 3G-enabled handsets will reach close to 395 million by 2013-end.

Exchange rate used:

1 USD = 48.21 INR (as on July)

1 USD = 47.81 INR (as on September)

FIIS

Foreign Institutional Investors is used to denote an investor; it is mostly of the form of an institution or entity which invests money in the financial markets of a country. The term FII is most commonly used in India to refer to companies that are established or incorporated outside India, and is investing in the financial markets of India. These investors must register with the Securities & Exchange Board of India to take part in the market.

Foreign investment refers to investments made by residents of a country in another country’s financial assets and production processes. After the opening up of the borders for capital movement, foreign investments in India have grown enormously. It affects the productivity factors of the receiver country and has the potential to create a ripple effect on the bop of the country. In developing countries like india, foreign capital helps in increasing the productivity of labor and to build up foreign exchange reserves to meet the current account deficit. It provides a channel through which these countries can have access to foreign capital.

Foreign investments can be of two forms: foreign direct investment and foreign portfolio investment. FDI involves direct production activity and has a medium to long term investment plans. In contrast the FPI has a short term investment horizon. They mostly investment in the financial markets which consist of FIIs. They invest in domestic financial markets like money market, stock market, foreign exchange market etc.

FIIs ‘investments are volatile in nature, and they mostly invest in the emerging markets. They usually keep in mind the potential of a particular market to grow.

FII has lead a significant improvement in India relating to the flow of foreign capital during the period of post economic reforms. The inflow of FII investments has helped the stock market to raise at a greater height according to financial analysts. Sensex touched a new height. It crossed 10000-mark in Jan 2006 which was 9323 in 2005. FII participation in the Indian stock market triggers its upward movement, but at the same time increased liquidity through FII investment inflow increases volatility.

HISTORY OF FII

India opened its stock market to foreign investors in September 1992, and in 1993, received portfolio investment from foreigners in the form of foreign institutional investment in equities. This has become one of the main channels of FII in India for foreigners. Initially, there were many terms and conditions which restricted many FIIs to invest in India.

But in the course of time, in order to attract more investors, SEBI has simplified many terms such as: –

  • The ceiling for overall investments of FIIs was increased 24% of the paid up capital of Indian company.
  • Allowed foreign individuals and hedge funds to directly register as FIIs.
  • Investment in government securities was increased to US $ 5 Billion.
  • Simplified registration norms.

P-NOTES (Participatory Notes) are instruments used by foreign investors that are not registered with the Securities & Exchange Board of India to invest in Indian stock markets. For example, Indian-based brokerages buy India-based securities and then issue Participatory Notes to foreign investors. Any dividends or capital gains collected from the underlying securities go back to the investors. That is why they are also called Offshore Derivative Instruments. Trading through Participatory Notes is easy because participatory notes are like contract notes transferable by endorsement and delivery. Secondly, some of the entities route their investment through Participatory Notes to take advantage of the tax laws of certain preferred countries. Thirdly, Participatory Notes are popular because they provide a high degree of anonymity, which enables large hedge funds to carry out their operations without disclosing their identity.

The first question that we need to ask is the necessity of FIIs as an instrument for investment into India. This is not a common place of markets; if, for example, a non-resident of the US or of England chooses to invest in an American or an English or a German stock, he does not have to hold his investment indirectly through an FII, but can hold it directly in his own name. An FII in India is a superfluous addition created simply to suit the regulatory requirements of SEBI.

FIIs serve no economic purpose but they exist in order to provide SEBI with a bureaucratic layer between a foreign investor and the regulator. It enables SEBI to pretend that it controls foreign investors when in fact SEBI has no control on the ultimate investor. It is a good example of obscuring the true character of foreign investment in India through a non-transparent and expensive set-up. The P-Note is an additional twist in this indirect investment as it enables those who wish to invest in the Indian market to do so without disclosing their identity.

FIIs impact on the Indian economy:

The Indian stock markets are both shallow and narrow and the movement of stock depends on limited number of stocks. As FIIs purchases and sells these stocks there is a high degree of volatility in the stock market. If any set of development encourages outflow of capital that will increase the vulnerability of the situation. The high degree of volatility can be attributed to the following reasons:

  • The increase in investments by FIIs increases stock indices in turn increases the stock prices and encourages further investments. In this event, if any correction takes place the stock prices declines and there will be full out by the FIIs in large number as earning per share declines.
  • The FIIs manipulate the situation of boom in such a manner that they wait till the index raises up to a certain height an exit at an appropriate time. This tendency increases the volatility further.

So even though the portfolio investment by FIIs increases the flow of money in the economic system, it may create problems of inflation.

FII’s Influence in Indian Stock Market

Institutional Investor is any investor or investment fund that is from or registered in a country outside of the one in which it is currently investing. Institutional investors include hedge funds, insurance companies, pension funds and mutual funds. The growing Indian market had attracted the foreign investors, which are called Foreign Institutional Investors to Indian equity market, and in this paper, we are trying a simple attempt to explain the impact and extent of foreign institutional investors in Indian stock market.

What does the name FII means? It is the abbreviation of Foreign Institutional Investors. The term is used most commonly in India to refer to outside companies investing in the financial markets of India. International institutional investors must register with the Securities & Exchange Board of India to participate in the market. One of the major market regulations pertaining to FIIs involves placing limits on FII ownership in Indian companies. They actually evaluate the shares and deposits in a portfolio. The major source (almost 50%) of money the FIIs invest is from the issue of Participatory Notes (P-Notes) or what are sometimes called Offshore Derivatives.

There are over 1484 FIIs and 38 foreign brokers registered to Securities & Exchange Board of India. We are also examining whether market movement can be explained by these investors. We often hear that whenever there is a rise in market, it is explained that it is due to foreign investors’ money and a decline in market is termed as withdrawal of money from FIIs.

After 1991, due to our liberalization process, there was large flow of foreign funds from abroad. Investments by FII are Rs. 2,55,464.40 Crores as compared to Rs. 2,83,468.40 Crores by the end of 31 December 2007. That implies that they had withdrawn almost 9% of money they had deposited till December 2007. The amount was much in the months of 2008 as compared to corresponding months of 2007, and that is a reason for the volatility of the stock market. In 2008, the net buying is only Rs. 5,603 Crores compared to Rs. 36,869 Crores in 2007.

A more investments by FIIs indicate that they are confident in Indian market. Usually, the mode of operations of FIIs was taking loans from countries where interest is low (like Japan) and invests in booming markets like India.

But the sub-prime crisis and other economic conditions had caused a liquidity crunch for these institutions. So they are forced to withdraw money from Indian market so as to repay loans they had taken. These withdrawals had caused panic in market, and even domestic investors are making them sell their shares.

But one aspect we should agree on is that the FII’s increased role had changed the face of Indian stock market. It had brought both quantitative and qualitative change. It had also increased the market depth and breadth. Emphasize is on fundamentals had caused efficient pricing of shares. Since there is no condition on FIIs that they should disclose in which company they are investing, those figures are not available.

Many qualitative tests like regression tests had proved that there is direct relation between market movements and fund flows of FIIs. In this, we will analyze the investments in different months and years, and tries to find the impact of FIIs in stock market.

Investments of FIIs on Indian Stock Market

The current investments of FIIs is Rs. 2,55,464.40 Crores. This is almost 9% of the total market capitalization. If we explain the things in simple terms, market pundits often attribute the rally of stock market and fall of stock market to the flow of funds by FIIs. We often hear the terms “FIIs Fuel the Market Run”. If we analyze the impacts, then the major impacts are: –

  • They increased depth and breadth of the market.
  • They played major role in expanding securities business.
  • Their policy on focusing on fundamentals of the shares had caused efficient pricing of shares.

These impacts made the Indian stock market more attractive to FIIs and also domestic investors, which involve the other major player Mutual Funds. The impact of FIIs is so high that whenever FIIs tend to withdraw the money from market, the domestic investors become fearful and they also withdraw from market.

Just to show the impact, we analyze below the 10 biggest falls of stock market: –

Day (Point loss in India)

Gross Purchase (Rs. Crores)

Gross Sales (Rs. Crores)

Net Investments (Rs. Crores)

21/01/2008 (1408)

3062.00

1060.30

2001.80

22/01/2008 (875)

2813.30

1618.20

1195.10

18/01/2008 (687)

1077.20

1348.40

-271.20

17/12/2007 (826)

670.00

869.00

-199.00

21/11/2007 (678)

640.70

791.80

-151.10

18/10/2007 (717)

1107.00

1372.50

-265.50

16/08/2007 (643)

989.50

750.30

239.20

02/08/2007 (617)

534.50

542.00

-7.50

01/08/2007 (615)

809.40

956.90

-147.50

18/05/2006 (856)

761.80

527.40

234.40

Major Intra Day Collapses in BSE Sensex

From this table, we can see that the major falls are accompanied by the withdrawal of investments by FIIs. Take the case on January 18, 2008, the Sensex lost almost 687 points. Here, the net sales by FIIs were Rs. 1348.40 Crores. This is a major contributor to the fall on that day. But contrary to that day, take the case on January 21, 2008, the Sensex lost 1408 points and the gross sales was Rs. 1060.30 Crores and the purchases were Rs. 3062.00 Crores. So this can be concluded that after the fall of market, FIIs had invested again into the market. From this, we can see the effect of FIIs.

Net Investments of FII from 2006-09

Year

Net Investment

2006

36539.7

2007

71486.5

2008

-29169

2009

15281.8

Now we analyze the net investments’ graph from 2006 to 2008. From this, we can see that there was small decrease in investments in the year 2006. But there was a steep increase in the year 2007-08. This was the best period in Indian stock market where stock prices were increased and the market was in good mood.

When we take the investments in 2008, the net investments is negative.


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