THIRD YEAR BACHELOR OF COMMERCE (FINANCIAL MARKETS) SEMESTER-V 2012-13
MODEL COLLEGE, DOMBIVALI UNIVERSITY OF MUMBAI OCTOBER-2012
A PROJECT REPORT ON VOLATILITY IN INDIAN STOCK MARKET AND FOREIGN INSTITUTIONAL INVESTOR
SUBMITTED TO THE UNIVERSITY OF MUMBAI IN PARTIAL FULFILLMENT FOR THE AWARD OF THE DEGREE OF BACHELOR OF COMMERCE FINANCIAL MARKETS SEMESTER V
BY CHOPADA PRANJAL VASANT
MODEL COLLEGE, DOMBIVALI UNIVERSITY OF MUMBAI OCTOBER 2012
TABEL OF CONTENTS SR NO. DESCRIPTION PAGE NO. 1. CERTIFICATE I 2. DECLARATION II 3. ACKNOWLEDGEMENT III 4. LIST OF ABBREVATIONS IV 5. LIST OF CHARTS / GRAPHS V 6. CHAPTER. 1 VOLATILITY IN INDAIN STOCK MARKET AND FOREIGN INSTITUTIONAL INVESTORS.
1 7. CHAPTER. 2 INDIAN STOCK MARKET A THEORETICAL VIEW 7 8. CHAPTER. 3 IMPACT OF FIIs ON STOCK MARKET INSTABILITY 30 9. CHAPTER. 4 CONCLUSION 37 10. ANNEXURE MILESTONES OF FII IN INDIAN STOCK MARKET 41 11. BIBLIOGRAPHY 44 12. WEBLIOGRAPHY 45
DECLARATION
I, PRANJAL CHOPDA STUDENT OF BACHELOR OF COMMERCE, FINANCIAL MARKETS, SEMESTER V OF KERALEEYA SAMAJAM DOMBIVALIS MODEL COLLEGE, HEREBY DECLARE THAT I HAVE COMPLETED PROJECT REPORT ON VOLATILITY IN INDIAN STOCK MARKET AND FOREIGN INSTITUTIONAL INVESTOR FOR THE ACADEMIC YEAR 2012-13.
THE INFORMATION SUBMITTED IS TRUE AND ORIGINAL TO THE BEST OF MY KNOWLEDGE.
PRANJAL CHOPADA BACHELOR OF COMMERCE FINANCIAL MARKETS
ACKNOWLEDGEMENT I would like to extent my sincere gratitude to all those people who have helped in the successful completion of my project entitled VOLATILITY IN INDIAN STOCK MARKET AND FOREIGN INSTITUTIONAL INVESTORS I would also like to express my deep sense of my gratitude to Mrs. REENA PILLAI, the faculty member, for her help and untrying efforts constant inspiration and stimulating guidance to me in my academics endeavor and in my project. I would also like to thank the college for giving me this opportunity for doing this project. I would also like to thank my family for giving me the support to do the same. I would also like to express my sincere thanks to all my friends who help me in finding the information and support for the successful completion.
PRANJAL CHOPADA
LIST OF ABBREVATION BSE : Bombay Stock Exchange CAPM : Capital Asset Pricing Model CMR : Call Money Rate EMEs : Emerging market economies EMEs : Emerging Market Economies FII : Foreign Institutional Investment FIIN : Net Foreign Institutional Investment FIIP : Foreign Institutional Investment- Purchase FIIS : Foreign Institutional Investment-Sale FPI : Foreign Portfolio Investment GDP : Gross Domestic Product IIP : Index of Industrial Production KYC : Know Your Client NRIs : Non-Resident Indians NSE : National Stock Exchange OCBs : Overseas Corporate Bodies QIPs : Qualified Institutional placements RBI : Reserve Bank of India SEBI : Securities and Exchange Board of India VAR : Vector Auto Regression
LIST OF TABELS / GRAPHS Sr No. Table Particular 1. NO. OF REGISTERED FIIs IN INDIA
2. FIIs INFLOWS AND SENSEX MOVEMENT
3. FREQUENCY DISTRIBUTION OF FII HOLDINGS IN SENSEX COMPANIES
4. FOREIGN INVESTMENT IN VARIOUS COUNTRIES IN TERMS OF THE % OF GLOBAL INVESTMENT IN US$
5. VOLATILITY OF STOCK MARKET RETURNS AS PER TRADITIONAL MEASURES(DAILY DATA)
Sr No. Graph particulars 1. NUMBER OF REGISTERED FIIs 2. Debt and Equity FII flow
CHAPTER 1
Volatility in Indian Stock Markets and Foreign Institutional Investors
The safe way to double the money is to fold it over once and put it in your pocket.
CHAPTER: 1 VOLATILITY IN INDAIN STOCK MARKET AND FOREIGN INSTITUTIONAL INVESTORS
Many developing countries, including India, restricted the flow of foreign capital till the early 1990s and depended on external aid and official development assistance. Later, most of the developing countries opened up their economies by dismantling capital controls with a view to attracting foreign capital, supplementing it with domestic capital to stimulate domestic growth and output.
Since then, portfolio flows from foreign institutional investors (FII) have emerged as a major source of capital for emerging market economies (EMEs) such as Brazil, Russia, India, China and South Africa. Besides, the surge in foreign portfolio flows since 1990s can be attributed to greater integration among international financial markets, advancement in information technology and growing interest in EMEs among FIIs such as private equity funds and hedge funds so as to achieve international diversification and reduce the risk in their portfolios.
Economic growth is a function of, among other things, capital formation. As FII flows are a source of non-debt creating capital for the economy, many EMEs have been competing with each other to
attract such flows through flexible investment norms/regulations or by offering fiscal sops. Further, FIIs have been assured decent returns on their investments, enabling continuous and sustainable investment flows.
FII flows into India registered substantial growth from a meager US$4 million in 199293 to over US$ 32 billion in 201011 (SEBI, 2011: 76). FII inflows underwent a sea-saw movement in India during the last decade. They registered spectacular growth especially since the middle of 2003 due to the higher growth rate in Indian GDP, robust corporate performance and an investment-friendly environment. Portfolio investment flows into India turned negative (outflow of US$ 12 billion) during 200809 (ibid.) mainly due to the heightened risk aversion of foreign investors, emanating from the global financial meltdown.
Ever since foreign portfolio investors were allowed to invest in Indian financial markets in September 1992, there have been extensive deliberations on the impact of such flows. It is said that portfolio flows from FIIs inject global liquidity into the capital markets, raise the price- to-earnings ratios, thereby reducing the cost of capital. This, in turn, leads to further issues of equity capital and stimulates investment growth in the host economy, apart from bringing in best international corporate governance practices. Yet, FIIs have been targets of criticism due to characteristics such as return chasing behaviour,
herd mentality, hot money flows, short-term speculative gains and their influence on domestic policy-making.
Though numerous research studies have been conducted in respect of FII flows into India, most of them have been confined to assessing the impact of such flows on stock markets. Very few studies have focused on the overall impact of FII flows on all segments of the Indian financial markets, viz., the capital market, the foreign exchange market, the money market and other macro-economic variables, such as inflation, money supply and Index of Industrial Production (IIP). Given this background, it is all the more relevant to undertake a cause and-effect study of FII flows into Indian financial markets in a holistic manner, by considering various macro-economic parameters, such as IIP, interest rates, inflation, exchange rates, apart from the BSE Sensex, so as to enable policymakers to take informed decisions in this regard. The present study examines the causes and effects of FII net flows into Indian financial markets with the support of empirical data for the period April 2003March 2011, i.e., a time span of eight years, covering the period before, during and after the eruption of the global financial crisis.
ABOUT THE REPORT
Title of the study:
The present study is titled as A PROJECT REPORT ON Volatility in India n Stock Markets and Foreign Institutional Investors. The study made with special reference to Foreign Institutional Investors.
Objectives of Study:
To study in depth FDI & FII & its role in Indian stock market. To know the changing scenario of Indian stock market after FII investment and various aspects of FII.
Data and Methodology:
For the purpose of the present study Secondary data were used. The data is collected from Books , Journals & websites.
Limitations of the Study:
The study has got all the limitations of using Secondary data and Inferences were made based on that.
SCOPE OF THE STUDY:
The report examines The Impact of Foreign Institutional Investments and Foreign Direct Investment on Equity Stock Market in India. The scope of the research comprises of information derived from secondary data from various websites. The various information and statistics were derived from the websites of BSE, NSE, Money Control, RBI and SEBI. Sensex and Nifty was a natural choice for inclusion in the study, as it is the most popular market indices and widely used by market participants for benchmarking.
Chapter Layout:
The Present study is arranged as follows.
Chapter 1 Gives an Introduction to volatility in Indian stock market and foreign institutional investors.
Chapter 2 Deals with the Theoretical view of Indian Stock Market.
Chapter 3 Deals with the impact of FIIs on stock market instability.
Chapter 4 Summarizes the result of study.
Chapter 5 Annexure - milestones of foreign institutional investment in Indian stock market
CHAPTER 2
DEALS WITH INDIAN STOCK MARKET A THEORETICAL VIEW
If you want to rear financial blessings, you have to sow financially.
CHAPTER 2. INDIAN STOCK MARKET - A THEORETICAL VIEW Diversifying globally i.e., holding a well diversified portfolio of securities from around the globe in proportion to market capitalizations, irrespective of investors country of residence, has long been advocated as means to reduce overall portfolio risk and maximize risk-adjusted returns by the traditional capital asset pricing model (CAPM). Foreign investment inflow depends on returns in the stock market, rates of inflation (both home and foreign), and extant risk. In terms of magnitude, the impact of stock market returns and the ex-ante risk turned out to be the key determinants of FII inflows. An investment will always carry the consideration of risk factor in its risk-return behaviour. In an investment friendly environment the bullish behaviour dominates the trends and at a given huge volume of investments, foreign investors may play a role of market makers and book their profits, i.e., they can buy financial assets when the prices are declining thereby jacking-up the asset prices and sell when the asset prices are increasing (Gordon & Gupta, 2003). Hence, there is a possibility of bi-directional relationship between FII and the equity returns. Although FII flows help supplement the domestic surplus resources and augment domestic investments without rising the foreign debt of the recipient countries, helps to maintain stabilized balance of payments particularly current account segment. Entry of
FII may also leads to decrease the required rate of return for equity, and improve stock prices of the host economies / nations. However, there are uncertainties about the defenselessness of recipient countrys capital markets to such flows. FII flows, often referred to as 'hot money' (i.e., short-term and overly tentative), are extremely unstable in character compared to other forms of capital flows. Foreign portfolio investors are regarded as 'fair weather friends' who come in when there is money to be made and leave at the first sign of impending trouble in the host country thereby destabilizing the domestic economy of the recipient country. Often, they have been blamed for exacerbating small economic problems in the host nation by making large and concerted withdrawals at the slightest hint of economic weakness. It is also alleged that as they make frequent marginal adjustments to their portfolios on the basis of a change in their perceptions of a country's solvency rather than variations in underlying asset value, they tend to spread crisis even to countries with strong fundamentals thereby causing 'contagion' in international financial markets.
Several research studies on FII flows to emerging market economies (EMEs) over the world have found that financial market infrastructure like market size, market liquidity, trading cost, extent of informational dissemination etc., legal mechanisms relating property rights, harmonization of corporate governance, accounting, listing and other rules with those followed in developed economies etc., are some of the important determinants of foreign portfolio investments into
emerging markets. The Securities and Exchange Board of India (SEBI) and Reserve Bank of India (RBI) have initiated several measures such as allowing overseas pension funds, mutual funds, investment trusts and asset management companies, banks, institutional portfolio managers, universal funds, endowments, easing the norms for registration of FIIs, reducing procedural delays, lowering the fees of registration, mandating strict disclosure norms, improved regulatory mechanisms etc. all these are supported by strong fundamentals, have made India as one of the attractive destinations for FIIs. The following table highlights the registered FIIs in India during the period from 2006 to 2010.
From the above table it is clear that there is constant growth in the number of registered FIIs in India. In the year 2006(January, 2006), the number of registered FIIs were 833 only. The same number has been increased to 1697 by the year 2010 (January 2010). The number has been increased by more than 100 per cent. In spite of the global financial crisis the number of registered FIIs has shown a significant increase. Irrespective of the situation in Indian stock
markets these FIIs has earmarked their presence. But the investment made by FIIs has experienced drastic decline in the recent past. This is mainly because of the global economic meltdown. Though the number of registered FIIs increased the net investments were not increased proportionately. The important reasons for growth in number of registered FIIs are easing of registration norms, lowering the registration fees, reducing the procedural delays. The most important is strong economical foundation of Indian economy. Though the entire globe affected with the global financial meltdown, India could face the global financial meltdown effectively. Compared too many other markets Indian markets are offering attractive returns on the investments. The growth rates of Gross Domestic Product (GDP) even during the financial crisis was attractive than many other economies. This resulted in increased number of registered FIIs in the last half decade. The following table (Table 2) provides a cross section of data on the FIIs inflow and stock market movement from the year 2000 to 2011(31stMay). The FIIs and hedge funds had pulled out money mainly due to higher interest rates in U.S. after Federal Reserve increased 7interest rates to 4.5% under their new governor. Similar changes took place many times in the history since opening and few times in the study.
Additional indicators and data reflect that movements in the SENSEX during the two years have clearly been driven by the behaviour of foreign institutional investors (FIIs), who were responsible for net equity purchases of as much as $6.6 and $8.5 billion respectively in 2003 and 2004. The Pearson correlation values indicate positive correlation between the foreign institutional investments and the movement of Sensex. (The value of Pearson correlation is 0.570894)
The above table (Table:3) shows the proportion of investment made by the FIIs in Sensex scrips. It is observed that almost
half of the companies are equipped with FII investment to the tune of 10% to 20%. Nearly 25% of the companies (Sensex 30 scrips) are having the FII investment between 30% and 40%. Another important thing is all the thirty scrips are showing the presence of foreign institutional investment. The pattern of change is also very minimal in respect of these companies regard to FIIs are concerned. It can be understood that the FIIs may enter and exit frequently form the other scrips but not the Sensex scrips. The above table depicts the consistency of FIIs over a period of time.
From the above table (Table:3) it can be understood that fifty percent of the companies which are included in BSE SENSEX are having fifteen to twenty percent of capital from the overseas. This indicates the level of influence by the foreign institutional investment on those companies particularly and on the stock market in general. Any withdrawal of foreign institutional investment may result in huge volatility in the market as well as share price movements. Similarly, any increase in the shareholding pattern by the foreign institutional investors may result huge rally in the market. The
psychology of domestic investors is also affected by the decisions of foreign institutional investors.
Being an agricultural based economy India has faced large number of problems while establishing industries. After independence, to establish core industries such as Iron & Steel, Cement, Electrical and construction of Roads, buildings etc. it took decades. Indian economy has experienced the problem of capital in many instances. Particularly, to start large scale industries where capital requirement was more. While planning to start the steel companies under government control, due to shortage of resources it has taken the aid of foreign countries. Likewise we have received aid from Russia, Britain and Germany for establishing Bhiloy, Rourkela and Durgapur steel plants. The foreign institutional investment was increased during the years 2006 and 2007. Later on, due to global financial crisis the investments by FIIs were reduced.
ADVANTAGES OF FII IN INDIAN MARKET
Enhanced flows of equity capital FIIs have a greater appetite for equity than debt in their asset structure. The opening up the economy to FIIs has been in line with the accepted preference for non-debt creating foreign inflows over
foreign debt. Enhanced flow of equity capital helps improve capital structures and contributes towards building the investment gap. Managing uncertainty and controlling risks. FII inflows help in financial innovation and development of hedging instruments. Also, it not only enhances competition in financial markets, but also improves the alignment of asset prices to fundamentals. Improving capital markets. FIIs as professional bodies of asset managers and financial analysts enhance competition and efficiency of financial markets. Equity market development aids economic development. By increasing the availability of riskier long term capital for projects, and increasing firms incentives to provide more information about their operations, FIIs can help in the process of economic development. Improved corporate governance. FIIs constitute professional bodies of asset managers and financial analysts, who, by contributing to better understanding of firms operations, improve corporate governance. Bad corporate governance makes equity finance a costly option. Also, institutionalization increases dividend payouts, and enhances productivity growth.
DISADVANTAGES OF FII IN INDAIN MARKET
Problems of Inflation: Huge amounts of FII fund inflow into the country creates a lot of demand for rupee, and the RBI pumps the amount of Rupee in the market as a result of demand created. Problems for small investor: The FIIs profit from investing in emerging financial stock markets. If the cap on FII is high then they can bring in huge amounts of funds in the countrys stock markets and thus have great influence on the way the stock markets behaves, going up or down. The FII buying pushes the stocks up and their selling shows the stock market the downward path. This creates problems for the small retail investor, whose fortunes get driven by the actions of the large FIIs. Adverse impact on Exports: FII flows leading to appreciation of the currency may lead to the exports industry becoming uncompetitive due to the appreciation of the rupee. Hot Money: Hot money refers to funds that are controlled by investors who actively seek short-term returns. These investors scan the market for short-term, high interest rate investment opportunities. Hot money can have economic and financial repercussions on countries and banks. When money is injected into a country, the exchange rate for the country gaining the money strengthens, while the exchange rate for the country losing the money weakens. If money is withdrawn on short notice, the banking institution will experience a shortage of funds.
FII and FDI connection: The relationship between FII and FDI (Foreign Direct Investment) is intertwined. In 1998 1999 a number of reforms were initiated, that were designed specifically for attracting FDI. In India FDI is allowed through FIIs. This is done through private equity, preferential allotment, joint ventures and capital market operations. The only industries in which FDI isnt allowed are arms, railways, coal, nuclear and mining. 100% financing by FDI is allowed in infrastructural projects such as construction of the bridges and the tunnels. In the financial sector, insurance and banking operations can have foreign investors.
Differences between FII & FDI: FDI and FIIs are two important sources of foreign financial flows into a country. FDI (Foreign Direct Investment) the acquisition abroad of physical assets such as plant and equipment, with operating control residing in the parent corporation. It is an investment made to acquire a lasting management interest (usually 10 percent of voting stock) in an enterprise operating in a country other than that of the investor, the investors purpose being an effective voice in the management of the enterprise. It includes equity capital, reinvestment of earnings, other long-term capital, and short-term capital. Usually countries regulate such investments through their periodic policies. In India such regulation is usually done by the Finance Ministry at the Centre through the Foreign Investment Promotion Board).
Types of Investments: FDI typically brings along with the financial investment, access to modern technologies and export market. The impact of the FDI in India is far more than that of FII largely because the former would generally involve setting up of production base - factories, power plant, telecom networks, etc. that enables direct generation of employment. There is also multiplier effect on the back of the FDI because of further domestic investment in related downstream and upstream projects and a host of other services. Korean Steel maker Pascos USD 8 billion steel plants in Orissa would be the largest FDI in India once it commences. Maruti Suzuki has been an exemplary case in the India's experience. However, the issue is that it puts an impact on local entrepreneur as he may not be able to always successfully compete in the face of superior technology and financial power of the foreign investor. Therefore, it is often regulated that Foreign Direct Investments should ensure minimum level of local content, have export commitment from the investor and ensure foreign technology transfer to India.FII investments into a country are usually not associated with the direct benefits in terms of creating real investments. However, they provide large amounts of capital through the markets. The indirect benefits of the market include alignment of local practices to international standards in trading, risk management, new instruments and equities research. These enable markets to become more deep, liquid, feeding in more information into prices resulting in a better allocation of capital to globally competitive sectors of the
economy. Foreign Institutional Investors Since, these portfolio flows can technically reverse at any time, the need for adequate and appropriate economic regulations are imperative.
Government Preference: FDI is preferred over FII investments since it is considered to be the most beneficial form of foreign investment for the economy as a whole. Direct investment targets a specific enterprise, with the aim of enhancing capacity and productivity or changing its management control. Direct investment to create or augment capacity ensures that the capital inflow translates into additional production. In the case of FII investment that flows into the secondary market, the effect is to increase capital availability in general, rather than availability of capital to a particular enterprise. Translating an FII inflow into additional production depends on production decisions by someone other than the foreign investor some local investor has to draw upon the additional capital made available via FII inflows to augment production. In the case of FDI that flows in for acquiring an existing asset, no addition to production capacity takes place as a direct result of the FDI inflow. Just like in the case of FII inflows, in this case too, addition to production capacity does not result from the action of the foreign investor the domestic seller has to invest the proceeds of the sale in a manner that augments capacity or productivity for the foreign capital inflow to boost domestic production. There is a widespread notion that FII
inflows are hot money that it comes and goes, creating volatility in the stock market and exchange rates. While this might be true of individual funds, cumulatively, FII inflows have only provided net inflows of capital
Stability: FDI tends to be much more stable than FII inflows. Moreover, FDI brings not just capital but also better management and governance practices and, often, technology transfer. The know-how thus transferred along with FDI is often more crucial than the capital per se. No such benefit accrues in the case of FII inflows, although the search by FIIs for credible investment options has tended to improve accounting and governance practices among listed Indian companies.
Types of FIIs: FII investments in India can be of the TWO types: 1. Normal FIIs: FII allocation of its total investment between equity and non-equity instruments (including dated government securities and treasury bills in the Indian capital market) should not exceed the ratio of 70:30. Equity related instruments would include fully convertible debentures, convertible portion of partially convertible debentures and tradable warrants.
2. 100% Debt FIIs: FII that can invest the entire corpus in dated government securities including treasury bills, non-convertible debentures/bonds issued by an Indian company subject to limits, if any. A FII needs to submit a clear statement that it wishes to be registered as FII/sub-account under 100% debt routes.
Entities which can register as FIIs: Entities who propose to invest their proprietary funds or on behalf of "broad based" funds (fund having more than twenty investors with no single investor holding more than 10 per cent of the shares or units of the fund) or of foreign corporate and individuals and belong to any of the under given categories can be registered for FII. Pension Funds Mutual Fund Investment Trust Insurance or reinsurance companies Endowment Funds University Funds Foundations or Charitable Trusts Charitable Societies who propose to in On their own behalf, and
Asset Management Companies Nominee Companies Institutional Portfolio Managers Trustees Power of Attorney Holders Banks Foreign Government Agency Foreign Central Bank International or Multilateral Organization or an Agency
Trends in FIIs: In 1993, when investments in FII s were introduced, Picket Umbrella Trust Emerging Markets Fund, an institutional investor from Switzerland, Indian market. While in 1994, no new registrations were reported, between 1995 and 2003, an average of 51 new FIIs began operations in the country each year. The graph below clearly indicates the steep increase in number of FII to the number of registered FIIs at the end of each calendar year). Currently, there are 1,695 registered FIIs and 5,264 registered sub accounts (As on 11th September, 2009).
Since 1993 when FIIs were first allowed to enter the India, there has always been a preference towards investing in equity than debt. The following graph shows the debt and equity FII flows.
FII investments through QIPs: QIPs are private placements or issuances of certain specified securities by Indian listed companies to qualified institutional buyers in accordance with the provisions of SEBI guidelines.
Qualified Institutional placements or QIPs were introduced in mid- 2006. Indian companies that are listed on stock exchanges having nationwide terminals the BSE and NSE have been raising capital through the QIP route. Quarterly Institutional buyers are preferred primarily because these entities have a large risk appetite, possess the general expertise and have the experience to make an informed decision. In August 2008, SEBI liberalized the pricing conditions for QIPs by reducing the period of reckoning to an average of two weeks stock price, prior to the relevant date, against the earlier requirement of taking the higher of the previous six months or 15 days average price. The pre-existing slowdown in the markets led to attractive valuations for the investors. Companies have taken advantage of this revision in pricing guidelines .Unitech, raised Rs 1,621 cores in April 2009 at Rs 38.50 per share, and again raised Rs. 2,760 crores in July 2009 at Rs 81 per share. Other companies which successfully raised capital through QIPs were HDIL, Shobha Developers, Network 18, Dewan Housing and Bajaj Hindustan. Most of the companies which came out with QIPs were in the real-estate/infrastructure sector. However, some companies like GMR Infrastructure were not so successful and had to withdraw their issue and GVK Power and Infrastructure had to scale down by nearly 60% due to problems in the valuations. Domestic institutional investors,
especially life insurers kept away from the QIPs on valuation concerns. However, FIIs which were net sellers had purchased Rs 9,500 crores in the same period. This led several FIIs to pick up the target stocks via QIP before the July 6thBudget and offload the same after the budget session. As per a CRISIL study, 10 out of 13 QIPs are currently quoting below the offer price. Since most of QIPs were in the reality and infrastructure sectors, one explanation is that FIIs came in expecting some quick gains from significant sops to the infrastructure and housing sectors in the Budget. It is also possible that the rush for QIPs was driven largely by short-term considerations, where the FIIs hedged their bets by taking short positions in the issuers stock even as they bought into the offers.
New sources of FII funds: The Securities and Exchange Board of India is in talks with the Cayman Islands Monetary Authority (Cima), over allowing funds based in the Caribbean into the country. Cayman Islands is one of the worlds largest tax havens and a lot of global hedge funds are based out of Cayman Islands Sebi has received numerous applications from Cayman-based funds since June when Cima was admitted as a full member of the international body of securities market regulators, the International Organization of Securities Commissions (Iosco).
Iosco's constituents regulate more than ninety percent of the world's securities markets. Funds from Cayman Islands were usually not favoured by SEBI owning to lack of transparency and difficulty in establishing the owner base. Consequently, these investments were viewed unfavorably and any Cayman fund seeking to invest in India had to be carefully examined. Post Caymans admission to Iosco, Sebi is now determining which grades of investment funds can be admitted expeditiously and which should be examined more carefully. Presently, there are 19 registered foreign institutional investors from Cayman Islands, taking the total to 19. The two recent additions have been Fir Tree Capital Opportunity Master Fund and Fir Tree Value Master Fund. The fund base of Cayman Islands is huge. There are about 9870 funds based there. Indian markets can expect more inflow from Cayman Island if SEBI agrees to let them come in.
REASONS FOR FDI:
Invest by Companies Overseas Companies choose to invest in foreign markets for a number of reasons, often the same reasons for expanding their operations within their home country. The economist John Dunning has identified four primary reasons for corporate foreign investments.
Market seeking -
Firms may go overseas to find new buyers for goods and services. Market-seeking may happen when producers have saturated sales in their home market, or when they believe investments overseas will bring higher returns than additional investments at home. This is often the case with high technology goods.
Resource seeking - Put simply, a company may find it cheaper to produce its production a foreign subsidiary- for the purpose of selling it either at home or in foreign markets. The foreign facility may be able to obtain superior or less costly access to the inputs of production (land, labor, capital and natural resources) than at home.
Strategic asset seeking - Firms may seek to invest in other companies abroad to help build strategic assets, such as distribution networks or new technology. This may involve the establishment of partnerships with other existing foreign firms that specialize in certain aspects of production. Efficiency seeking - Multinational companies may also seek to reorganize their overseas holdings in response to broader economic changes. Fluctuations in exchange rates may also change the profit calculations of a firm, leading the firm to shift the allocation of its resources.
ACTS AND RULES: FII registration and investment are mainly governed by SEBI (FII) Regulations, 1995. ELIGIBILITY FOR REGISTRATION AS FII: Following entities / funds are eligible to get registered as FII: 1. Pension Funds 2. Mutual Funds 3. Insurance Companies 4. Investment Trusts 5. Banks 6. University Funds 7. Endowments 8. Foundations 9. Charitable Trusts / Charitable Societies Further, following entities proposing to invest on behalf of broad based funds (a fund established or incorporated outside India, which has at least twenty investors with no single individual investor holding more than 10% shares or units of the fund), are also eligible to be registered as FIIs:
Asset Management Companies Institutional Portfolio Managers Trustees Power of Attorney Holders
INVESTMENT OPPORTUNITIES FOR FIIs The following financial instruments are available for FII investments a) Securities in primary and secondary markets including shares, debentures and warrants of companies, unlisted, listed or to be listed on a recognized stock exchange in India; b) Units of mutual funds; c) Dated Government Securities; d) Derivatives traded on a recognized stock exchange; e) Commercial papers. Investment limits on equity investments a) FII, on its own behalf, shall not invest in equity more than 10% of total issued capital of an Indian company. b) Investment on behalf of each sub-account shall not exceed 10% of total issued capital of an India company. c) For the sub-account registered under Foreign Companies/ Individual category, the investment limit is fixed at 5% of issued capital. These limits are within overall limit of 24% / 49 % / or the sectoral caps a prescribed by Government of India / Reserve Bank of India.
Investment limits on debt investments The FII investments in debt securities are governed by the policy if the Government of India. Currently following limits are in effect: For FII investments in Government debt, currently following limits are applicable: For corporate debt the investment limit is fixed at US $ 500 million.
TAXATION: The taxation norms available to a FII are shown in the table below. Nature of Income Tax Rate Long-term capital gains 10% Short-term capital gains 30% Dividend Income Nil Interest Income 20% Long term capital gain: Capital gain on sale of securities held for a period of more than one year. Short term capital gain: Capital gain on sale of securities held for a period of less than one year.
CHAPTER 3
Impact of FIIs on Stock Market Instability
The real measure of your wealth is how much youd be worth if you lost all your money.
CHAPTER 3 IMPACT OF FIIS ON STOCK MARKET INSTABILITY
Investment of FIIs are motivated not only by the domestic and external economic conditions but also by short run expectations shaped primarily by what is known as market sentiment. The element of speculation and high mobility in FII investment can increase the volatility of stock return in emerging markets. In fact, a widely held perception among academicians and practitioners about the emerging equity markets is that price or return indices in these markets are frequently subject to extended deviations from fundamental values with subsequent reversals and that these swings are in large part due to the influence of highly mobile foreign capital. Volatility is an unattractive feature that has adverse implications for decisions pertaining to the effective allocation of resources and therefore investment. Volatility makes investors averse to holding stock due to increased uncertainty. Investors in turn demand higher risk premium so as to ensure against increased uncertainty. A greater risk premium implies higher cost of capital and consequently lowers physical investment. In addition, great volatility may increase the option to wait thereby delaying investment. Also weak regulatory system in emerging market economies (EMEs) reduce the efficiency of market
signals and the processing of information, which further magnifies the problem of volatility. But some researchers have the opposite assumption of non-disestablishing hypothesis that says FIIs have no adverse impact
Trading by FIIs happens on a continuous basis and therefore has a lasting impact on the local stock market. There is, however, surprisingly little empirical evidence on the impact of FIIs trading on the host countrys stock return volatility, thereby making it imperative that this aspect of local equity markets, which is important for both risk analysis and portfolio construction, be examined. This chapter attempts to fill the gap. Beside the introduction, this chapter is classified into two parts. Part I presents the impact of foreign institutional investors on the Indian stock market volatility. Part II shows the structure of the volatility before and after introduction of the foreign institutional investors in Indian stock market.
The scope of the study is limited to the India which has become an attraction for FIIs in recent years, in fact the emerging markets of many developing countries have been attracting large inflows of private capital in recent years. The surge in capital flows occurred first in Latin America, then South East Asia and is now clearly visible
in South Asia. A significant feature of these capital flows is the increasing importance of foreign portfolio investment (FPI), whose buying and selling of stocks on a daily basis determines the magnitude of such capital flows. A significant improvement has also taken place in India relating to the flow of foreign capital during the period of post economic reforms. The major change in the capital flows particularly in Foreign Institutional Investors (FIIs) investments has taken place following the changes in trade and industrial policy. Over the past 15 years or so India has gradually emerged an important destination of global investors investments in emerging equity markets. In 2006, India had a share of about 0.55% of global investment which is quite high in comparison to year 2001 in which Indias share was only 0.12%. On the other hand some of the developed countries have shown a downward trend.
The foreign financial inflows, beside other factors, helped the Indian stock market to rise at a great height according to financial analysts. Sensex crossed a new high. It crossed 20000- mark in December 2007, which was 13786.91 in December 2006 and 9397.93 In December 2005. This historical movement is also due to the other parameters of the economy, which are favorable for the investment. The returns on investment are also much favorable. The profit performance of the firms may explain the reasons for High return on investment. There are other factors such as favorable tax laws and relaxation on the caps of various kinds of investments. The policy measures and economic factors are also the reasons for the investors confidence.
during 1981-90, period of real sector reforms, were significantly higher than those found pre-liberalization period (i.e.1961-80). Interestingly, return and volatility increase further to 0.074 and 1.92 respectively. In era of first generation reforms financial sector reforms
(i.e. 1991-2000).It is appreciable to see from the table that the second generation reforms have brought in more cheers for the capital market as the risk (i.e. Standard Deviation of return) decreased but the stock return went up in the period. Clearly the volatility has declined in Indian stock market after year 2000. Table 5 further reveals that the stock return has remained around half (0.06%) after the arrival of FIIs as compared to that obtained (0.15%) during 1986 to 1992 period. Simultaneously, the standard deviation which measures the volatility has declined from 2.1598 percent during 1986-92 to 1.59 percent during 1992-2007. Thus, both volatility and return have declined after the opening up of domestic stock market for FIIs. Time period 1994 to 2001 gave a serious setback to stock market performance.
Increase cap on G-Sec Bond Markets: Currently, the cap on FII investments in the bond market is USD 6 Billion. As per the new budget, proposes to borrow Rs.4.5 lakh crore in 2009-10 to support its infrastructure and other developmental projects. This could be opened up to the FIIs so that they can take part in Indias hitherto almost closed debt market. The Indian debt markets are not fully developed and see low volumes. The lifting of the cap on FIIs will increase the traded volumes and it will also help in preventing the crowding out of investment for private enterprises.
Allow dollar settlements in India: The suggestion by SEBI to permit dollar settlements for FIIs would revolutionize the way in which they invest in the country. This will help mitigate risks of currency fluctuations for FIIs, and help in improve the volume and liquidity of the derivatives market. With dollar settlements, many participants, who want to take exposure to Indian markets through index buying, will be able to participate freely. This, in turn, will give stability to Indian markets as there will be buying of underlying stocks by the sellers of these contracts to FIIs. At present, settlements in India are done in rupee denominations. As a result, a number of FIIs, who intend to trade in Nifty futures, take the Singapore route where CNX Nifty index futures are traded on SGX. About 50 per cent of the total open interest (OI) build-up in Nifty futures takes place on the SGX, which allows settlements in US dollar. This enables different types of FIIs to operate there. Also, low transaction costs due to the absence of securities transaction tax, stamp duty and P-note complications have resulted in a gradual shift of FIIs into offshore markets. Settlements in dollar would also help in reducing the volatility in dollar-rupee conversion value caused due to FII flows. Each time a settlement is done, a seller of futures contracts to an FII would buy an equivalent amount of underlying stocks to hedge his/her exposure due to the sale. This
would increase the trading volume and liquidity of Indian markets, once dollar settlement is allowed.
Stricter implementation of regulation to curb p-notes etc.
To prevent the misuse of the participatory notes, there should be stricter implementation of the regulations. Tough implementation of KYC norms should be done. In the long run, the group is of the opinion that registration procedures for FIIs should be made simpler after which P-Notes should be done away with.
CHAPTER 4
CONCLUSION
Those who start with too little money are more likely to succeed than those who start with too much. Energy and imagination are the springboards to wealth creation.
CHAPTER 4. CONCLUSION A number of studies in the past have observed that investments by FIIs and the movements of Sensex are quite closely correlated in India and FIIs wield significant influence on the movement of Sensex (Rangarajan 2000, Samal 1997, Pal 1998). NSE (2001) also observes that in the Indian stock markets FIIs have a disproportionately high level of influence on the market sentiments and price trends. This is so because other market participants perceive the FIIs to be infallible in their assessment of the market and tend to follow the decisions taken by FIIs. This herd instinct displayed by other market participants amplifies the importance of FIIs in the domestic stock market in India.
It is clear that the FIIs are influencing the Sensex movement to a greater extent. Further it is evident that the Sensex has increased when there are positive inflows of FIIs and there were decrease in Sensex when there were negative FII inflows. It has been perceived in some quarters that FII flows are major drivers of stock markets in India and hence a sudden reversal of flows may harm the stability of its markets. The nature of relationship between FII flows and Indian stock market returns can be explained in terms of cumulative informational disadvantage of foreign portfolio investors vis-a-vis domestic investors. The theory says that domestic investors
posses better knowledge about Indian financial markets than foreign investors and this information asymmetry leads to positive feedback trading by the foreign portfolio investors. There is no doubt FIIs are influencing the movement of Sensex to a greater extent.
The whole process also highlights another disturbing feature. During the post election period, the sudden volatility in the stock market and the subsequent decline of Sensex was almost treated as a national emergency in India by the financial media and to a certain extent, by the incoming UPA government. It is very difficult to understand why the government feels so concerned about speculative investors and the movements in Sensex. Most studies have shown that Sensex is neither a good barometer of economic fundamentals it is not an indicator of future growth prospects of the economy. Moreover, this study also shows that even sharp changes in Sensex do not necessarily indicate a significant alteration of actual shareholding pattern of different investor groups even in the Sensex companies. As far as the real economy is concerned, the stock market has a very limited role to play. In India, for the year 2002-03, new capital issues by non- government public limited companies raised a combined capital of Rs 1,878 crores from ordinary shares, preference share and debentures. This amount is only 0. 33 percent of gross domestic capital formation of the economy and about 1. 6 percent of gross domestic capital formation by private corporate sector for that year. This is not surprising because even in developed stock market s like
USA, the stock market has not been a significant source of finance for new investments. Also, stock markets mobilize a very s mall fraction of household financial saving in India. As the recent RBI Handbook of Statistics shows, investment in shares and debentures10 and units of UTI account for only 1.37 percent of total household financial savings for t h e y ear 2003- 04. In comparison, bank deposits account for about 42 .8 percent of household financial savings for the same year. Under this circumstance s, it is not clear why so much importance is given to the stock market and portfolio investors by policy makers in India. It is high time to realize that in spite of the impression given by the financial media, movements of stock markets and Sensex do not necessarily imply any fundamental changes in the economy and these movements affect a very small minority of the country s population. It will be unfortunate if movements of speculative capital and the resultant stock market gyrations are allowed to influence macro-economic policy making in India. Results of this study show that not only the FIIs are the major players in the domestic stock market in India, but their influence on the domestic markets is also growing. Data on trading activity of FIIs and domestic stock market turnover suggest that FIIs are becoming more important at the margin as an increasingly higher share of stock market turnover is accounted for by FII trading. Moreover, the findings of this study also indicate that Foreign Institutional Investors have emerged as the most dominant investor group in the domestic stock market in India. Particularly, in the companies that constitute
the Bombay Stock Market Sensitivity Index (Sensex) and NSE Nifty, their level of control is very high. Dominant position of FIIs in the Sensex companies, it is not surprising that FIIs are in a position to influence the movement of Sensex and Nifty in a significant way.
Since FIIs are dominating the Indian Market, individual investors are forced to accept the dictates of major FIIs and hence join the group by entering the Mutual Fund group. Many Mutual Funds floated specific funds for the sectors favored by the FIIs. An implication of MFs gaining strength in the Indian stock market could be that unlike individual investors, whose monies they manage, MFs can create market trends whereas the small individual investors can only follow the trends. The situation becomes quite difficult if the funds gain a vested interest in certain sectors by floating sector specific funds. One can even venture to say that the behaviour of MFs in India has turned the very logic that mutual funds invest wisely on the basis of well-researched strategies and individual investors do not have the time and resources to study and monitor corporate performance, upside down. Thus, the entry of FIIs has not resulted in greater depth in Indian stock market; instead it led to focusing on only a few sectors. Ultimately to provide a level playing field, even the domestic investors had to be offered lower rates of capital gains tax.
CHAPTER 5
ANNEXURE
Fortune knocks once, but misfortune has much more patience.
ANNEXURE
MILESTONES OF FOREIGN INSTITUTIONAL INVESTMENT IN INDIAN STOCK MARKET
India embarked on a programme of economic reforms in the early 1990s to tie over its balance of payment crisis and also as a step towards globalisation. An important milestone in the history of Indian economic reforms happened on September 14, 1992, when the FIIs (Foreign Institutional Investors) were allowed to invest in all the securities traded on the primary and secondary markets, including shares, debentures and warrants issued by companies which were listed or were to be listed the stock exchanges in India and in the schemes floated by domestic mutual funds. Initially, the holding of a single FII and of all FIIs, NRIs (Non- Resident Indians) and OCBs (Overseas Corporate Bodies) in any company was subject to a limit of 5% and 24% of the company's total issued capital respectively. ( In order to broad base the FII investment and to ensure that such an investment would not become a camouflage for individual investment in the nature of FDI (Foreign Direct Investment), a condition was laid down that the funds invested by FIIs had to have at least 50 participants with no one holding more than 5%. Ever since
this day, the regulations on FII investment have gone through enormous changes and have become more liberal over time. ( From November 1996, FIIs were allowed to make 100% investment in debt securities subject to specific approval from SEBI as a separate category of FIIs or sub-accounts as 100% debt funds. Such investments were, of course, subjected to the fund-specific ceiling prescribed by SEBI and had to be within an overall ceiling of US $ 1.5 billion. The investments were, however, restricted to the debt instruments of companies listed or to be listed on the stock exchanges. In 1997, the aggregate limit on investment by all FIIs was allowed to be raised from 24% to 30% by the Board of Directors of individual companies by passing a resolution in their meeting and by a special resolution to that effect in the company's General Body meeting. (From the year 1998, the FII investments were also allowed in the dated government securities, treasury bills and money market instruments. (In 2000, the foreign corporates and high net worth individuals were also allowed to invest as sub-accounts of SEBI-registered FIIs. FIIs were also permitted to seek SEBI registration in respect of sub- accounts. This was made more liberal to include the domestic portfolio managers or domestic asset management companies. (40% became the ceiling on aggregate FII portfolio investment in March 2000.
(This was subsequently raised to 49% on March 8, 2001 and to the specific sectoral cap in September 2001.
(As a move towards further liberalization a committee was set up on March 13, 2002 to identify the sectors in which FIIs portfolio investments will not be subject to the sectoral limits for FDI.
(Later, on December 27, 2002 the committee was reconstituted and came out with recommendations in June 2004. The committee had proposed that, 'In general, FII investment ceilings, if any, may be reckoned over and above prescribed FDI sectoral caps. The 24 per cent limit on FII investment imposed in 1992 when allowing FII inflows was exclusive of the FDI limit. The suggested measure will be in conformity with this original stipulation.' The committee also has recommended that the special procedure for raising FII investments beyond 24 per cent up to the FDI limit in a company may be dispensed with by amending the relevant regulations.
(Meanwhile, the increase in investment ceilingfor FIIs in debt funds from US $ 1 billion to US $ 1.75 billion has been notified in 2004. The SEBI also has reduced the turnaround time for processing of FII applications for registrations from 13 working days to 7 working days except in the case of banks and subsidiaries.
All these are indications for the country's continuous efforts to mobilize more foreign investment through portfolio investment by FIIs. The FII portfolio flows have also been on the rise since September 1992. Their investments have always been net positive, but for 1998- 99, their sales were more than their purchase.
CHAPTER 6
BIBLIOGRAPHY
No matter how hard you hug your money, it never hugs back.
BIBLIOGRAPHY
BOOKS: FOREIGN DIRECT INVESTMENT BY- M. SORNARAJAH FOREIGN INSTITUTIONAL INVESTORS BY- VIJAYCHANDRA KUMAR C
MAGAZINE: INDAIN JOURNALS OF MARKETING MARCH 10, MAY 12.
NEWS PAPER: ECONOMICS TIMES TIMES OF INDIA DNA
CHAPTER 7
WEBLIOGRAPHY
I dont think about financial success as the measurement of my success.