Table of content

Introduction.2 About foreign direct investment...3 Foreign direct investment: Indian scenario...3 Introduction to FII..5 Market design in India for FII..9 Bibliography..10

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INTRODUCTION
Foreign investment refers to investments made by the residents of a country in the financial assets and production processes of another country. The effect of foreign investment, however, varies from country to country. It can affect the factor productivity of the recipient country and can also affect the balance of payments. Foreign investment provides a channel through which countries can gain access to foreign capital. It can come in two forms: foreign direct investment (FDI) and foreign institutional investment (FII). Foreign direct investment involves in direct production activities and is also of a medium- to long-term nature. But foreign institutional investment is a short-term investment, mostly in the financial markets. FII, given its short-term nature, can have bidirectional causation with the returns of other domestic financial markets such as money markets, stock markets, and foreign exchange markets. Hence, understanding the determinants of FII is very important for any emerging economy as FII exerts a larger impact on the domestic financial markets in the short run and a real impact in the long run. India, being a capital scarce country, has taken many measures to attract foreign investment since the beginning of reforms in 1991. India is the second largest country in the world, with a population of over 1 billion people. As a developing country, Indias economy is characterized by wage rates that are significantly lower than those in most developed countries. These two traits combine to make India a natural destination for foreign direct investment (FDI) and foreign institutional investment (FII). Until recently, however, India has attracted only a small share of global foreign direct investment (FDI) and foreign institutional investment (FII), primarily due to government restrictions on foreign involvement in the economy. But beginning in 1991 and accelerating rapidly since 2000, India has liberalized its investment regulations and actively encouraged new foreign investment, a sharp reversal from decades of discouraging economic integration with the global economy. The world is increasingly becoming interdependent. Goods and services followed by the financial transaction are moving across the borders. In fact, the world has become a borderless world. With the globalization of the various markets,
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international financial flows have so far been in excess for the goods and services among the trading countries of the world. Of the different types of financial inflows, the foreign direct investment (FDI) and foreign institutional investment (FII)) has played an important role in the process of development of many economies. Further many developing countries consider foreign direct investment (FDI) and foreign institutional investment (FII) as an important element in their development strategy among the various forms of foreign assistance.

About foreign direct investment

Is the process whereby residents of one country (the source country) acquire ownership of assets for the purpose of controlling the production, distribution, and other activities of a firm in another country (the host country). The international monetary funds balance of payment manual defines FDI as an investment that is made to acquire a lasting interest in an enterprise operating in an economy other than that of the investor. The investors purpose being to have an effective voice in the management of the enterprise. The united nations 1999 world investment report defines FDI as an investment involving a long term relationship and reflecting a lasting interest and control of a resident entity in one economy (foreign direct investor or parent enterprise) in an enterprise resident in an economy other than that of the foreign direct investor ( FDI enterprise, affiliate enterprise or foreign affiliate).

Foreign direct investment: Indian scenario

Foreign Direct Investment (FDI) is permitted as under the following forms of investments Through financial collaborations. Through joint ventures and technical collaborations. Through capital markets via Euro issues. Through private placements or preferential allotments.

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Forbidden Territories FDI is not permitted in the following industrial sectors:

Arms and ammunition. Atomic Energy. Railway Transport. Coal and lignite. Mining of iron, manganese, chrome, gypsum, sulphur, gold, diamonds, copper, zinc. Retail Trading (except single brand product retailing). Lottery Business Gambling and Betting Business of chit fund Nidhi Company Trading in Transferable Development Rights (TDRs). Activity/sector not opened to private sector investment

Foreign direct investments in India are approved through two routes

1. Automatic approval by RBI The Reserve Bank of India accords automatic approval within a period of two weeks (subject to compliance of norms) to all proposals and permits foreign equity up to 24%; 50%; 51%; 74% and 100% is allowed depending on the category of industries \ and the sectoral caps applicable. The lists are comprehensive and cover most industries of interest to foreign companies. Investments in highpriority industries or for trading companies primarily engaged in exporting are given almost automatic approval by the RBI.

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2. The FIPB Route Processing of non-automatic approval cases FIPB stands for Foreign Investment Promotion Board which approves all other cases where the parameters of automatic approval are not met. Normal processing time is 4 to 6 weeks. Its approach is liberal for all sectors and all types of proposals, and rejections are few. It is not necessary for foreign investors to have a local partner, even when the foreign investor wishes to hold less than the entire equity of the company. The portion of the equity not proposed to be held by the foreign investor can be offered to the public.

Introduction to FII
Since 1990-91, the Government of India embarked on liberalization and economic reforms with a view of bringing about rapid and substantial economic growth and move towards globalization of the economy. As a part of the reforms process, the Government under its New Industrial Policy revamped its foreign investment policy recognizing the growing importance of foreign direct investment as an instrument of technology transfer, augmentation of foreign exchange reserves and globalization of the Indian economy. Simultaneously, the Government, for the first time, permitted portfolio investments from abroad by foreign institutional investors in the Indian capital market. The entry of FIIs seems to be a follow up of the recommendation of the Narsimhan Committee Report on Financial System. While recommending their entry, the Committee, however did not elaborate on the objectives of the suggested policy. The committee only suggested that the capital market should be gradually opened up to foreign portfolio investments.

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From September 14, 1992 with suitable restrictions, FIIs were permitted 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 on the Stock Exchanges in India. While presenting the Budget for 1992-93, the then Finance Minister Dr. Manmohan Singh had announced a proposal to allow reputed foreign investors, such as Pension Funds etc., to invest in Indian capital market. To operationalise this policy announcement, it had become necessary to evolve guidelines for such investments by Foreign Institutional Investors (FIIs). The policy framework for permitting FII investment was provided under the Government of India guidelines vide Press Note date September 14, 1992. The guidelines formulated in this regard were as follows:
1) Foreign Institutional Investors (FIIs) including institutions such as Pension

Funds, Mutual Funds, Investment Trusts, Asset Management Companies, Nominee Companies and Incorporated/Institutional Portfolio Managers or their power of attorney holders (providing discretionary and non-discretionary portfolio management services) would be welcome to make investments under these guidelines.
2) FIIs would be welcome to invest in all the securities traded on the Primary and

Secondary markets, including the equity and other securities/instruments of companies which are listed/to be listed on the Stock Exchanges in India including the OTC Exchange of India. These would include shares, debentures, warrants, and the schemes floated by domestic Mutual Funds. Government would even like to add further categories of securities later from time to time.

3) FIIs would be required to obtain an initial registration with Securities and

Exchange Board of India (SEBI), the nodal regulatory agency for securities markets, before any investment is made by them in the Securities of companies listed on the Stock Exchanges in India, in accordance with these
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guidelines. Nominee companies, affiliates and subsidiary companies of a FII would be treated as separate FIIs for registration, and may seek separate registration with SEBI.
4) Since there were foreign exchange controls in force, for various permissions

under exchange control, along with their application for initial registration, FIIs were also supposed to file with SEBI another application addressed to RBI for seeking various permissions under FERA, in a format that would be specified by RBI for the purpose. RBI's general permission would be obtained by SEBI before granting initial registration and RBI's FERA permission together by SEBI, under a single window approach.

5) For granting registration to the FII, SEBI should take into account the track

record of the FII, its professional competence, financial soundness, experience and such other criteria that may be considered by SEBI to be relevant. Besides, FII seeking initial registration with SEBI were be required to hold a registration from the Securities Commission, or the regulatory organization for the stock market in the country of domicile/incorporation of the FII.
6) SEBI's initial registration would be valid for five years. RBI's general

permission under FERA to the FII would also hold good for five years. Both would be renewable for similar five year periods later on.

7) RBI's general permission under FERA would enable the registered FII to buy,

sell and realize capital gains on investments made through initial corpus remitted to India, subscribe/renounce rights offerings of shares, invest on all recognized stock exchanges through a designated bank branch, and to appoint a domestic Custodian for custody of investments held.
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8) This General Permission from RBI would also enable the FII to: a. Open foreign currency denominated accounts in a designated bank. (There could even be more than one account in the same bank branch each designated in different foreign currencies, if it is so required by FII for its operational purposes); b. Open a special non-resident rupee account to which could be credited all receipts from the capital inflows, sale proceeds of shares, dividends and interests; c. Transfer sums from the foreign currency accounts to the rupee account and vice versa, at the market rate of exchange; d. Make investments in the securities in India out of the balances in the rupee account; e. Transfer repairable (after tax) proceeds from the rupee account to the foreign currency account(s); f. Repatriate the capital, capital gains, dividends, incomes received by way of interest, etc. and any compensation received towards sale/renouncement of rights offerings of shares subject to the designated branch of a bank/the custodian being authorized to deduct withholding tax on capital gains and arranging to pay such tax and remitting the net proceeds at market rates of exchange; g. Register FII's holdings without any further clearance under FERA. 9) There would be no restriction on the volume of investment minimum or maximumfor the purpose of entry of FIIs, in the primary/secondary market. Also, there would be no lock-in period prescribed for the purposes of such investments made by FIIs. It was expected that the differential in the rates of taxation of the long term capital gains and short term capital gains would automatically induce the FIIs to retain their investments as long term investments. 10) Portfolio investments in primary or secondary markets were subject to a ceiling of 30% of issued share capital for the total holdings of all registered FIIs, in any one
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company. The ceiling was made applicable to all holdings taking into account the conversions out of the fully and partly convertible debentures issued by the company. The holding of a single FII in any company would also be subject to a ceiling of 10% of total issued capital. For this purpose, the holdings of an FII group would be counted as holdings of a single FII. 11) The maximum holdings of 24% for all non-resident portfolio investments, including those of the registered FIIs, were to include NRI corporate and noncorporate investments, but did not include the following: a. Foreign investments under financial collaborations (direct foreign investments), which are permitted up to 51% in all priority areas. b. Investments by FIIs through the following alternative routes: i. Offshore single/regional funds; ii. Global Depository Receipts; iii. Euro convertibles.

Market design in India for foreign institutional investors

Foreign Institutional Investors means an institution established or incorporated outside India which proposes to make investment in India in securities. A Working Group for Streamlining of the Procedures relating to FIIs, constituted in April, 2003, inter alia, recommended streamlining of SEBI registration procedure, and suggested that dual approval process of SEBI and RBI be changed to a single approval process of SEBI. This recommendation was implemented in December 2003. Currently, entities eligible to invest under the FII route are as follows: i) As FII: Overseas pension funds, mutual funds, investment trust, asset management company, nominee company, bank, institutional portfolio manager, university funds, endowments, foundations, charitable trusts, charitable societies, a trustee or power of attorney holder incorporated or established outside India proposing to make proprietary investments or with no single investor holding more than 10 per cent of the shares or units of the fund).
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(ii) As Sub-accounts: The sub account is generally the underlying fund on whose behalf the FII invests. The following entities are eligible to be registered as subaccounts, viz. partnership firms, private company, public company, pension fund, investment trust, and individuals. FIIs registered with SEBI fall under the following categories: a) Regular FIIs- those who are required to invest not less than 70 % of their investment in equity-related instruments and 30 % in non-equity instruments. b) 100 % debt-fund FIIs- those who are permitted to invest only in debt instruments. The Government guidelines for FII of 1992 allowed, inter-alia, entities such as asset management companies, nominee companies and incorporated/institutional portfolio managers or their power of attorney holders (providing discretionary and nondiscretionary portfolio management services) to be registered as FIIs. While the guidelines did not have a specific provision regarding clients, in the application form the details of clients on whose behalf investments were being made were sought. While granting registration to the FII, permission was also granted for making investments in the names of such clients. Asset management companies/portfolio managers are basically in the business of managing funds and investing them on behalf of their funds/clients. Hence, the intention of the guidelines was to allow these categories of investors to invest funds in India on behalf of their clients'. These 'clients' later came to be known as sub-accounts. The broad strategy consisted of having a wide variety of clients, including individuals, intermediated through institutional investors, who would be registered as FIIs in India. FIIs are eligible to purchase shares and convertible debentures issued by Indian companies under the Portfolio Investment Scheme.

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BIBILOGRAPHY
Internet sites : a) www.rbi.org.in/home.aspx b) www.google.com c) www.fdimagazine.com d) www.members.aol.com/RTMadaan1/sectors e) http://dipp.nic.in/fdi_statistics/india_fdi_index.htm f) www.nseindia.com g) www.sebi.gov.in

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