fii & sensex

Foreign Institutional Investors

A PROJECT REPORT ON

FOREIGN INSTITUTIONAL INVESTORS AND

INDIAN STOCK MARKET

SUBMITTED IN PARTIAL FULFILLMENT OF

MASTERS OF MANAGEMENT STUDIES COURSE

BY RASHI GUPTA

MMS (FINANCE)

ROLL NO. 17

2007-09

JANKIDEVI BAJAJ INSTITUTE OF MANAGEMENT STUDIES

SNDT WOMEN’S UNIVERSITY

MUMBAI

APRIL 2009

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DECLARATION

I, Rashi Gupta, a student of Jankidevi Bajaj Institute of Management Studies, hereby

declare that I have completed the final project on “Foreign Institutional Investors and

Indian Stock Market”. The information submitted is true and original to the best of my

knowledge. Any references used in this report have been duly acknowledged.

Date: Signature of student

Place: Mumbai

Rashi Gupta

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ACKNOWLEDGEMENT

One of the most pleasant aspects of preparing a project report is the opportunity to thank

all those behind it.

First, at the very outset, I thank my guide, Prof. M A Ganachari, who always helped me.

He always inspired me through his deeds and gave me ample time to finish my year long

project. Thank you Sir.

I acknowledge my sincere gratitude to Dr. Gulnar Sharma, Director in charge, Jankidevi

Bajaj Institute of Management Studies, who motivated us to work on this project.

I would also like to thank the corporate executives who gave in-depth knowledge and

enlightening guidance, along with their valuable time throughout this project.

On this momentous occasion, I wish to express my inordinate gratitude to a range of

people, my friends, family, and my near and dear ones, who provided me with invaluable

support in this venture. Their enthusiastic guidance and encouragement has helped in

making this project a success.

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Contents

CHAPTER 1 - EXECUTIVE SUMMARY..........................................................7

CHAPTER 2 - LITERATURE REVIEWS..........................................................8

CHAPTER 3 – OBJECTIVES.........................................................................11

CHAPTER 4 – RESEARCH METHODOLOGY...............................................12

4.1 Objective.............................................................................................................13

4.2 Type of Research.................................................................................................13

4.3 Sampling.............................................................................................................13

4.4 Data Collection...................................................................................................14

4.5 Analysis Techniques............................................................................................14

4.6 Hypothesis..........................................................................................................14

CHAPTER 5 – INTRODUCTION...................................................................15

5.1 Indian Economy and Indian Capital Market.......................................................16

5.2 History................................................................................................................18

5.3 Foreign Institutional Investors in India...............................................................21

5.4 Difference between FII and FDI.........................................................................24

5.5 Foreign Institutional Investor: Overview............................................................26

5.6 Facts on Foreign Institutional Investor...............................................................28

5.7 Regulations.........................................................................................................40

5.8 Guidelines for investment by foreign institutional investors..............................43

5.9 RBI Guidelines for FII Investment.....................................................................47

5.10 Investment in Indian Companies by FIIs/NRIs/PIOs:......................................484


CHAPTER 6 - FEATURES AND REASONS FOR FII INVESTMENT................56

6.1 Attractive features for FII investment.................................................................57

6.2 Reasons for FIIs inflow in Indian market...........................................................61

6.3 Reasons for FIIs outflow in Indian market.........................................................61

6.4 Benefits and costs of FII investments:................................................................62

6.5 Effects of FII flow on the recipient country economy........................................65

6.6 FII holdings in Indian markets drops..................................................................66

CHAPTER 7 - TRENDS OF FOREIGN INSTITUTIONAL INVESTORS.............67

7.1 FII inflows from 2000 -2007..............................................................................68

7.2 Trends in FII registration....................................................................................69

7.3 FIIs with SENSEX:.............................................................................................71

CHAPTER 8 – ANALYSIS............................................................................72

8.1 Table of Net FII Investment and Sensex Value during 1999-2008....................73

8.2 Direct effects of the global crisis........................................................................74

8.3 Role of foreign investors.....................................................................................77

8.4 Liberalised rules..................................................................................................81

CHAPTER 9 – FINDINGS.............................................................................82

9.1 Findings from Table 1.1......................................................................................83

9.2 Impact of FIIs on the Indian Stock Markets in the near future...........................85

9.3 Expectations........................................................................................................86

9.4 Vulnerability to FII Flows..................................................................................87

CHAPTER 10 - CONCLUSION......................................................................88

CHAPTER 11 – REFERENCES......................................................................915


Table and Graphs

Table 1.1...................................................................................................73

Graph 1.1...................................................................................................74

Graph 1.2...................................................................................................75

Graph 1.3...................................................................................................76

Graph 1.4...................................................................................................77

Graph 1.5...................................................................................................78

Graph 1.6...................................................................................................80

Graph 1.7...................................................................................................81

Graph 1.8...................................................................................................83

Graph 1.9...................................................................................................83

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CHAPTER 1 - EXECUTIVE SUMMARY

Since the beginning of liberalization FII flows to India have steadily grown in

importance. As a part of its initiative to liberalize its financial markets, India opened her

doors to Foreign Institutional Investors in September 1992. This event represents a

landmark event since it resulted in effectively globalizing its financial services industry.

The foreign institutional investors (FIIs) have emerged as important players in the Indian

equity market in the recent past. This study makes an attempt to develop an

understanding of the dynamics of the trading behavior of FIIs. Along with this the

purpose of study is to find out the impact of FII inflows on Indian stock market, do we

need FII inflows? Do FII play an important role in Indian equity market? And at last

should we encourage FII inflows?

For this monthly, yearly data of FII inflow is taken into consideration. First, the

introduction about the Indian economy and FIIs is given followed by the conceptual

framework, guidelines, investing limits in Indian companies is observed. Second, trends

in FII flows and FII activities up to 2007 February are considered. This is followed by the

role of FIIs in the Indian stock market.

As per the study done it is found out that the trading behavior of FII do not have a

destabilizing impact on the equity market. It can be said that we can encourage FII

inflows into India through appropriate regulation of PNs and sub-accounts and invent a

series of check and balances system so as to protect the economy and look over the fact

that the economy works best with such kind of filters system. Thus, it can be said that FII

do play an important role in Indian equity market.

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CHAPTER 2 - LITERATURE REVIEWS

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A. 1Gayathri Devi .R in 2003, she conducted study on “Causal Relationship

between FIIs and Stock Market: A critical study”. It revealed that there was long run

relationship between net FII investment and Sensex, FII investment did not respond

the short-run changes or technical-position of the market and they were more driven

by fundamentals, and FII investments did granger cause India stock market.

B. Julia Priya, D. Lazar and Joseph Jeyapual in 2005, they conducted study on

“Role of Foreign Institutional Investors on stock market development in India”,

Results revealed that Sensex, market capitalization of NSE, Turnover of BSE and

NIFTY without market capitalizations were influenced by Foreign Institutional

Investors.

C. “Suchismita Bose and Dipankor coondoo” in 2004, they conducted study on

“The Impact of FII Regulation in India”, These results strongly suggested The

liberalization policies had the desired expansionary effect and had either increased the

mean level of FII inflows and/or the sensitivity of these flows to a change in BSE

returns.

D. Parthapratim pal in 2004 conducted study entitled as “Recent volatility in

stock markets in India and foreign institutional investors. Findings of this study

indicated that foreign institutional investors had 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, their level of control was

very high inertia of these flows.

E. “Sandhya Ananthanaryanan, Chandrasekhar krishnamurthi and Nilajan Sen in

2003 conducted study as “Foreign institutional Investors and Security Returns:

Evidence from Indian Stock Exchanges”, It found strong evidence consistent with the

base-broadening hypothesis. It did not find compelling confirmation regarding

momentum or contrarian strategies being employed by FIIs. It supported price

pressure hypothesis. It did not find any substantiation to the claim that foreigner’

destabilize the market.

1http://www.articlesbase.com/investing-articles/investment-from-abroad-is-right-or-wrong-216418.html

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F. J.S. Pasricha and Umesh.C.Singh in 2001, tried to analyze the impact of FIIs

investment on Indian capital market. Their study revealed that FII are here to stay and

have become the integral part of Indian capital market. Their entry has led to greater

institutionalization of the market. They have brought transparency in the market

operations.

G. Kumar in 2001 attempted his study to find the effect of FIIs on the Indian

stock market. The inference analysis of the paper suggests that FII investments are

more driven by market fundamentals rather than by short term changers or technical

position of the market.

H. As per K. Seethapathi and V. Subbulakshmi study entitled “Foreign

investment: Need for focus”, they concluded that, the flows have to pick up. The

political will is to be demonstrated by the government. In addition, the regulators have

to identify the reasons for failure in converting approvals into actual investments and

those issues are to be addressed immediately.

I. E. Han Kim and Vijay Singal in 1997, they conducted study entitled “Are open

market Good for Foreign Investors and Emerging Nations?” Conclusion revealed as.

Integrating the emerging stock markets into world markets has had benefits, and will

continue to have benefits for both global investor and host countries. The end result of

integrated markets a better allocation of resources, improved productivity of capital,

and a higher standard of living.

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CHAPTER 3 – OBJECTIVES

The objectives of this study were as follows

(1) To study the role of FII investment in the Indian stock market,

(2) To examine the causal relationship between net FII investment and BSE Sensex

(3) To examine whether FIIs were a channel of global disturbance into the Indian stock

market.

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CHAPTER 4 – RESEARCH METHODOLOGY

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Research Methodology is a systematic way of solving a problem it includes the research

methods for solving a problem.

4.1 Objective

To know about the role of FII investment in Indian stock market, relationship between

FII net investment with Sensex and FIIs are channel of global disturbance in stock

market.

4.2 Type of Research

The objective of the research is to find out the effect of Foreign Institutional Investors on

Indian Stock Market. Hence it is Descriptive type research.

Descriptive research is the description of the condition as it exists at present for example,

FIIs interest in stock market.

Data source - Secondary data

Data collection method - There will be no data collection method since data source is

secondary data.

Data collection tools – Internet, Books, and Research Papers.

Sampling universe – BSE

Sample size – 10 year data

4.3 Sampling

Design: The target population of the study consist of Indian Stock market more

specifically Bombay Stock Exchange. This survey was done by collecting data from

different sites like BSE, SEBI, and Equitymaster.

Universe: The sample universe of the research is Bombay Stock Exchange (BSE).

Size: After due consultation with the college guide, also keeping in mind the

requirements of the research, the sample size that was found to be appropriate for the

study was 10 year which started from 1999 to 2008.

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Technique: The sampling technique that was adapted to conduct the survey was

‘Random Sampling’ and the area of the research was concentrated on the Bombay Stock

Exchange only.

4.4 Data Collection

The task of data collection begins after a research problem has been defined. In this study

data was collected through secondary data source.

Secondary Data: Secondary data consist of information that already exits somewhere,

having been collected for some other purpose. In this study secondary data which is value

of SENSEX and net investment of FII was collected from the BSE and different

websites, SEBI Manual, magazines, and news papers.

4.5 Analysis Techniques

The statistical tools and techniques which were used mainly were –

Graphs

Graphs have been used to show the investment trends by FII’s.

Correlation

It is used to find out the relation between two variables.

4.6 Hypothesis

Null Hypothesis Ho = FIIs net investment in equity positively correlated to SENSEX

value.

Alternative Hypothesis Hₐ = FIIs net investment in equity negatively correlated to

SENSEX value.

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CHAPTER 5 – INTRODUCTION

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5.1 Indian Economy and Indian Capital Market

Second fastest growing economies after China with an average annual growth rate

of more than 8 per cent in the last three years

India’s growth rate has surpassed some of the developed economies

GDP at current market prices is over US $778 billion

Foreign investment can be made in India with specific prior approval in sectors

other than those prohibited

Foreign investment is now freely allowed in all sectors, including the services

sector subject to specified sect oral ceilings except in a few strategically sensitive

areas

Investments can be made through foreign venture capital funds

Qualified Institutional investors are allowed to invest in Indian Depository

Receipts floated by foreign companies. FIIs and NRIs can also invest in IDRs after

obtaining permission from RBI

FIIs can make investments in Corporate and Government Bond markets within

the limits

Household Investment in Shares and debentures as percentage of financial

savings at 4.9 per cent

Market capitalization of Rs.34,62,692 crore or over US $ 770 billion as on

November 17, 2006

India is the world’s 12th largest in market capitalization.

Market cap-GDP ratio is almost 100 per cent

With Sensex crossing 13,000 mark – ahead of most of the emerging economies

with a P/E ratio of 22.01

NSE (India’s National Stock Exchange) is the third largest in the world in the

number of trades after NYSE and NASDAQ

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India has 23 small and 2 big stock exchanges

The 2 big stock exchanges (National Stock Exchange and Bombay Stock

Exchange) account for 90 per cent of trade

Over 7000 listed companies on the stock exchanges – largest in the world

9040 brokers in cash segment and 1064 in derivative segment of the market

122 investment bankers in the market, 58 under writers to support primary issues,

34 foreign venture capital funds, 120 Portfolio managers, 11 custodian banks, 2

depositories with over 9 million beneficiary owner accounts, 120 Portfolio managers.

Number of traders at 20 million, Number of internet trading clients at 1.44

million, Internet trading at 12 per cent of total trading.

Rise in index during the last eighteen months over 100 per cent from 30

November 1996, Year on year return during the last year at 74 per cent.

Daily volatility of the market 0.76 per cent to 1.29 per cent

India launches Capital Protection Fund and Gold Exchange Traded Funds

About 1000 foreign institutional investors

Investors by foreign institutional investors at over $50 billion

At current prices, it is around 15 per cent of the total market capitalization

Only broad based entities established and incorporated abroad are eligible to be

registered as Foreign Institutional investors in India

FIIs can invest on behalf of their clients through sub-accounts

For normal FIIs, limit for investment in equity is at least 70 per cent while the rest

could be invested in debt up to a maximum limit of 30 per cent

FIIs could also be dedicated debt funds who can invest up to 100 per cent in debt

FIIs can issue overseas derivative instruments like Participatory Notes (PNs) to

the entities registered in the country of origin.

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5.2 2History

The character of global capital flows to developing countries underwent significant

changes on many counts during the 'nineties. By the time the East Asian financial crisis

surfaced, the overall size of the flows more than tripled. It stood at US$ 100.8 bn. in 1990

and rose to US$ 308.1 bn. by 1996. The increase was entirely due to the sharp rise in the

flows under private account that rose from US$ 43.9 bn. to 275.9 bn. during the same

period. In relative terms the percentage of private account capital flows increased from

43.55 to 89.55 per cent. Simultaneously, the Official Development Assistance (ODA)

declined both in relative and absolute terms. All the main components of the private

account capital transfers, namely, (a) commercial loans, (b) foreign direct investments

(FDI), and (c) foreign portfolio investments (equity and bonds) (FPI) recorded significant

increases. Portfolio flows increased at a faster rate than direct investments on private

account. As a result, starting with a low level of 11.16 percent, the share of capital flows

in the form of portfolio investments quadrupled to reach 37.22 per cent in 1996 reflecting

the enhanced emphasis on private capital flows with portfolio investments forming the

second important constituent of the flows during the 'nineties. In this process multilateral

bodies led by the International Finance Corporation (IFC) played a major role. Following

the East Asian financial crisis, initially there was a slow down followed, by a decline in

private capital flows. While bonds and portfolio equity flows reacted quickly and

declined in 1997 it, loans from commercial banks dropped a year later in 1998. Decline

in FDI was also delayed. But the fall in FDI was quite small compared to the other three

major forms of private capital flows. Thus, starting with the resolve by the developed

countries to provide 1 per cent of their GNP as developmental aid, the industrialised

world preferred to encourage private capital transfers through direct investments instead

of official assistance. The declining importance of official development finance is

attributed to budgetary constraints in donor countries and the optimism of private

investors in the viability of the developing countries.

Portfolio investments spread risk for foreign investors, and provide an opportunity to

share the fruits of growth of developing countries which are expected to grow faster.

Investing in emerging markets is expected to provide a better return on investments for

pension funds and private investors of the developed countries. For developing countries, 2 foreign institutional investments And the Indian stock market by K.s. chalapati rao, k.v.k. ranganathan and m.r. murthy at http://isidev.nic.in/pdf/FII&ISM.pdf

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foreign portfolio equity investment has different characteristics and implications

compared to FDI. Besides supplementing domestic savings, FDI is expected to facilitate

transfer of technology, introduce new management and marketing skills, and helps

expand host country markets and foreign trade. Portfolio investments supplement foreign

exchange availability and domestic savings but are most often not project specific.

FPI, are welcomed by developing countries since these are non-debt creating. FPI, if

involved in primary issues, provides critical risk capital for new projects. Since FPI takes

the form of investment in the secondary stock market, it does not directly contribute to

creation of new production capabilities. To enable FPI flows which prefer easy liquidity,

multilateral bodies, led by the International Finance Corporation (IFC), have been

encouraging establishment and strengthening of stock markets in developing countries as

a medium that will enable flow of savings from developed countries to developing

countries. FPI, it is expected, could help achieve a higher degree of liquidity at stock

markets, increase price-earning (PE) ratios and consequently reduce cost of capital for

investment. FPI is also expected to lead to improvement in the functioning of the stock

market as foreign portfolio investors are believed to invest on the basis of well-

researched strategies and a realistic stock valuation. The portfolio investors are known to

have highly competent analysts and access to a host of information, data and experience

of operating in widely differing economic and political environments. Host countries

seeking foreign portfolio investments are obliged to improve their trading and delivery

systems which would also benefit the local investors. To retain confidence of portfolio

investors host countries are expected to follow consistent and business friendly liberal

policies. Having access to large funds, foreign portfolio investors can influence

developing country capital markets in a significant manner especially in the absence of

large domestic investors. Portfolio investments have some macroeconomic implications.

While contributing to build-up of foreign exchange reserves, portfolio investments would

influence the exchange rate and could lead to artificial appreciation of local currency.

This could hurt competitiveness. Portfolio investments are amenable to sudden

withdrawals and therefore these have the potential for destabilising an economy. The

volatility of FPI is considerably influenced by global opportunities and flows from one

country to another. Though it is sometime argued that FDI and FPI are both equally

volatile the Mexican and East Asian crises brought into focus the higher risk involved in

portfolio investments.

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FPI and India

While foreign portfolio investments are not new to the Indian corporate sector, the

importance of portfolio investments received special impetus towards the end of 1992

when the Foreign Institutional Investors (FIIs) such as Pension Funds, Mutual Funds,

Investment Trusts, Asset Management Companies, Nominee Companies and

incorporated/institutional Portfolio Managers were permitted to invest directly in the

Indian stock markets. The entry of FIIs seems to be a follow up of the recommendation

of the Narasimham 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 stated: The Committee would also suggest that the capital

market should be gradually opened up to foreign portfolio investments and

simultaneously efforts should be initiated to improve the depth of the market by

facilitating issue of new types of equities and innovative debt instruments. Press reports

of early 1993 indicate that the Asian Department Bank (ADB) influenced the

Committee’s recommendations. Then ADB President's Report on India's Request for a

Financial Sector Program Loan, mentioned that: The Bank (ADB) had also called for

capital market reforms including allowing private mutual funds to operate, allowing

investment in Indian firms by foreign investors and allowing increased access to world

capital markets for India. Attracting foreign capital appears to be the main reason for

opening up of the stock markets for FIIs. The Government of India issued the relevant

Guidelines for FII investment on September 14, 1992. Only a few days prior to this, a

statement attributed to IFC suggested that India would have to wait for some years before

the expected large foreign investment materialises. Regarding the entry of FIIs the then

Finance Minister said at a meeting organised by the Royal Institute of International

Affairs (London) that the decision to open up the stock market to investments by foreign

companies would be good for the country as India needed international capital. He

further said that a non debt creating instrument such as this was superior to raising loans

of the classical type so that an unsustainable debt burden was not piled up.

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5.3 Foreign Institutional Investors in India

India opened her doors to foreign institutional investors in September, 1992. This event

represents a landmark event since it resulted in effectively globalizing its financial

services industry. Beginning 1996-97, the group was expanded to include registered

university funds, endowment, foundations, charitable trusts and charitable. Since then,

FII flows which form a part of foreign portfolio investments have been steadily growing

in importance in India. Other than in the year 1998, the net flows have been positive. The

nuclear tests and East Asian crisis did slow down the flows but as stated by Gordan and

Gupta (2003), their effects were short lived. That the percentage of total net turnover of

BSE, the share of average of FII sales and purchases increased from 2.6 percent in 1998

to 5.5 percent in 2002. The cumulative net FII investment in India as on August 2003 is

approximately $17400 million. As of August 2003 net FII investment was 9 percent of

the BSE market capitalization which is small compared to the size of the market.

However, in the words of Banaji (2002), it is not the market capitalization that matters

but what is important is the level of the free float, that is, the shares that are actually

publicly available for trading. With floating stock in the Indian market being less than 25

percent, about 35 percent of the free float available has been bagged by FIIs - despite the

fact that they invest in just a few highly liquid stocks.

Though India receives hardly 1 percent of the FII investments in emerging markets, the

portfolio flows to India have been less volatile when compared with that of many other

emerging markets. FIIs by adopting a bottom-up approach seem to invest in top-quality,

high growth, large cap stocks.

India is one of the fastest growing economies in South Asia, promising a growth of over

9 percent, second only to China; it would not be a surprise to see increased FII flows to

India in the future. FIIs are now looking at the economy as a whole, with the macro-

economic factors also playing their role in attracting foreign investors. Factors like a

strong currency, key reforms in the banking, power and telecommunications sector,

increased consumer spending and stable policies are expected to play a major role in

attracting FIIs to India. The Securities Exchange Board of India (SEBI) along with the

Institute of Chartered Accountants of India (ICAI) jointly monitor the markets and

announces the regulatory measures thus making the Indian companies more transparent

and more disciplined. 21


According to the April 2005 report on corporate governance by CLSA Emerging

Markets, India ranks fourth with a score of 55.6 percent. Banaji (2000) emphasizes that

the capital market reforms like improved market transparency, automation,

dematerialization and regulations on reporting and disclosure standards were initiated

because of the presence of the FIIs. But FII flows can be considered both as the cause

and the effect of capital market reforms. The market reforms were initiated because of

the presence of FIIs and this in turn has lead to increased flows.

The Government of India gave preferential treatment to FIIs till 1999-2000 by subjecting

their long term capital gains to lower tax rate of 10 percent while the domestic investors

had to pay higher long-term capital gains tax. The Indo-Mauritius Double Taxation

Avoidance Convention 2000 (DTAC), exempts Mauritius-based entities from paying

capital gains tax in India - including tax on income arising from the sale of shares. This

gives an incentive for foreign investors to invest in Indian markets taking the Mauritius

route. Consequently, we now see investments coming from Mauritius while there were

none before 2000.

The country wise distribution of the FIIs registered in India, with majority of them

coming from USA and UK. Chakrabarti (2002) and Rao et al. (1999) point out the fact

that due to existing inter-linkages, the source of the FII investment might not be the

country from where the institution operates. Nevertheless, the figure gives us an idea of

the country wise distribution of the FIIs in India. So as to encourage long term

investments in the Indian market, Budget 2003 proposed that investors who buy stocks of

listed companies from March 1, 2003 be exempt from paying tax on the gains they make

on their investments, provided they hold them for more than one year. With so much to

benefit from, the FII investment in India is likely to increase in the future.

Period 1991 to 1997

The Finance Minister also said that the liberalisation of the economy would bring in

international capital of about $10 bn. a year rising to $12-13 bn. over the following 2-3

years. It may also not be a mere coincidence that India decided to open its stock markets

to FII investments in the aftermath of the stock scam. The Sensex, BSE Sensitive Index,

fell to 2,529 on August 6, 1992 from the unprecedented high level of 4,467 reached on

April 22, 1992. As an incentive, FIIs were allowed lower rates for capital gains tax. This

22


was justified on the basis that this will guard against volatility in fund flows'. Indian

industry did protest against this and called for a level playing field. During the period

1992-93 to 1998-99 out of the total capital inflow to India of about US$28.6 bn., a little

more than US$ 15 bn. or nearly 54 per cent of the total, was on account of foreign

portfolio investments. These aggregate capital flows were a little less than the foreign

currency assets at the end of 1998-99. During the period, external debt did increase from

US$ 85 bn. to 98 bn. Much of the increase, however, took place by 1995. Thus, the

strategy of relying on non debt creating instruments seems to have yielded results. The

flows, however, did not match the initial expectation that capital flows will aggregate

US$ 12-13 bn. a year, i.e., nearly US$ 50-60 bn. for the five year period 1993 to 1997.

Within portfolio investments, FIIs had a share of nearly 50 per cent and GDRs 44 per

cent. From the point of capital flows and managing balance of payments, it does appear

that an active pursuance of GDRs could be a viable alternative to FII investments. Unlike

portfolio investments, GDRs are generally project specific and hence the benefits from

such issues are more tangible.

Period 1998 to 2004

It is period of greatest improvement in the Indian economy and its perception abroad.

The economy grew at 6.5% with an occasional burst of 8% in 2003. The foreign money

managers started to look at India favorably. Political instability diminished a bit.

Constrictions to the growth were slowly removed or reduced. That allowed the Foreign

Direct Investment (FDI) to increase. A total of about $3.5 Billion in FDI has reached

India in 2004. It compares unfavorably with China, which received $50 Billion, but it is

three times higher than what India received in 1998.

The economy today is performing better than it has ever performed in last 50 years. Still

it is not performing at its full potential. Additional outside investment is needed and

needed now to reach its stated 9% growth potential.

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5.4 3Difference between FII and FDI

FII, Foreign Institutional Investors, foreign investors invest in the markets of a foreign

country for example, insurance companies, investment companies, charitable

organizations etc. The concept of FII is very common in India. Such companies are just

required to register on the stock exchange or in the markets to make investments and

there is no board controlling it. FII is when a foreign company buys equity in a company

through the stock markets. Therefore, in this case, FII would not give the foreign

company any control in the company. On the other hand in FDI, Foreign Direct

Investment, in a foreign country to get at least 10% of voting stocks. It increases the

management interest in the enterprise of the other country. In very simple words, FDI is

an investment which a parent enterprise made in a foreign country. For example,

Multinational companies present the best examples of FDI like Telenor; the seventh

largest company in the world has a number of companies in various countries. The

daughter companies of Telenor Group act as the FDI for the host countries. In most of the

states there is an FDI board which is responsible to handle FDI coming in the country

like in India, one of the attractive FDI country, there is Foreign Investment Promotion

Board (FIPB). FDI is when a foreign company brings capital into a country or an

economy to set up a production or some other facility. FDI gives the foreign company

some control in the operations of the company.

Inflow of foreign capital, whether in the form of FDI or FII, is good for any recipient

country provided they are allowed in a measured way. If FDIs are invited more in the

infrastructure sectors, it could prove to be a boom for the economy. But if these capital

inflows come more in the consumer sectors, chances are that in the long run it could be

proved to be disastrous for the economy/country. For example if the recipient country of

FDIs invites more and more capital into the automobile sector to have vast varieties of

cars, scooter, motorcycles etc. in the country, but if the growth of the automobile sector is

not matched by the proper roads as well as the capacity of the country to generate or

import petrol or diesel, at a macro level, the growth of automobile sector might prove to

be a liability for the country simply because the country will be more dependent on the

3 http://www.financialexpress.com/news/fii-vs-fdi/127133/

24


international markets for buying petrol/diesel. Poor roads, inefficient and outdated

railway's technology, outdated railways tracks etc. etc. will add the consumption of

petrol/diesel. This way whatever would come in as a foreign exchange through an inflow

of foreign capital will be drained out in buying petrol/diesel from international markets

for sheer consumption purposes? Similar cases could be in other sectors too.

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5.5 4Foreign Institutional Investor: Overview

One who propose to invest their proprietary funds or on behalf of "broad based" funds or

of foreign corporate and individuals and belong to any of the under given categories can

be registered for FII.

Pension Funds

Mutual Funds

Investment Trust

Insurance or reinsurance companies

Endowment Funds

University Funds

Foundations or Charitable Trusts or Charitable Societies who propose to invest on

their own behalf, and

Asset Management Companies

Nominee Companies

Institutional Portfolio Managers

Trustees

Power of Attorney Holders

Bank

An application for registration has to be made in Form A, the format of which is provided

in the SEBI (FII) Regulations, 1995 and submitted with under mentioned documents in

duplicate addressed to SEBI as well as to Reserve Bank of India (RBI) and sent to the

following address within 10 to 12 days of receipt of application.

Supporting documents required are

Application in Form A duly signed by the authorised signatory of the applicant.

Certified copy of the relevant clauses or articles of the Memorandum and Articles of

Association or the agreement authorizing the applicant to invest on behalf of its clients

Audited financial statements and annual reports for the last one year, provided that the

period covered shall not be less than twelve months.

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A declaration by the applicant with registration number and other particulars in

support of its registration or regulation by a Securities Commission or Self Regulatory

Organisation or any other appropriate regulatory authority with whom the applicant is

registered in its home country.

A declaration by the applicant that it has entered into a custodian agreement with a

domestic custodian together with particulars of the domestic custodian.

A signed declaration statement that appears at the end of the Form.

Declaration regarding fit & proper entity.

The eligibility criteria for applicant seeking FII registration

As per Regulation 6 of SEBI (FII) Regulations, 1995, Foreign Institutional Investors are

required to fulfil the following conditions to qualify for grant of registration:

Applicant should have track record, professional competence, financial soundness,

experience, general reputation of fairness and integrity;

The applicant should be regulated by an appropriate foreign regulatory authority in the

same capacity/category where registration is sought from SEBI. Registration with

authorities, which are responsible for incorporation, is not adequate to qualify as Foreign

Institutional Investor.

The applicant is required to have the permission under the provisions of the Foreign

Exchange Management Act, 1999 from the Reserve Bank of India.

Applicant must be legally permitted to invest in securities outside the country or its in-

corporation / establishment.

The applicant must be a "fit and proper" person.

The applicant has to appoint a local custodian and enter into an agreement with the

custodian. Besides it also has to appoint a designated bank to route its transactions.

Payment of registration fee of US $ 5,000.00

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5.6 5Facts on Foreign Institutional Investor

Definitions:

Q1. Who is a Foreign Institutional Investor (FII)?

Answer. FII means an entity established or incorporated outside India which proposes to

make investment in India.

Q2. What is a sub-account?

Answer. Sub-account includes those foreign corporations, foreign individuals, and

institutions, funds or portfolios established or incorporated outside India on whose behalf

investments are proposed to be made in India by a FII.

Q3. What is a Designated Bank?

Answer. Designated Bank means any bank in India which has been authorized by the

Reserve Bank of India to act as a banker to FII.

Q4. Who is a Domestic Custodian?

Answer. Domestic Custodian means any entity registered with SEBI to carry on the

activity of providing custodial services in respect of securities.

Q5. What is a Broad Based Fund?

Answer. Broad Based Fund means 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.

Provided that the fund has institutional investor(s), it is not necessary for that fund to

have twenty investors.

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Provided further that the fund has an institutional investor holding more than 10% of

shares or units in the fund, and then the institutional investor must itself be broad based

fund.

FII Registration:

Q6. What are the parameters on which SEBI decides FII applicants’ eligibility?

Answer.

A. Applicant’s track record, professional competence, financial

soundness, experience, general reputation of fairness and integrity. (The applicant should

have been in existence for at least one year)

B. whether the applicant is registered with and regulated by an appropriate

Foreign Regulatory Authority in the same capacity in which the application is filed with

SEBI

C. Whether the applicant is a fit & proper person.

Q7. Which form needs to be filled in when applying for FII registration?

Answer. "Form A" as prescribed in SEBI (FII) Regulations, 1995.

Q8. Which documents need to be sent with "Form A"?

Answer.

A. Certified copy of relevant clauses (clauses permitting the stated activities) of

Memorandum of Association, Article of Association or Article of Incorporation.

B. Audited financial statement and annual report for the last one year (period covered

should not be less than twelve months

Q9. How much is the fee for registration as FII?

Answer. US $ 5,000

Q10. When is the registration fee payable?

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Answer. At the time of submitting the application forms of registration.

Q11. What is the mode of payment?

Answer. Demand Draft in favour of "Securities and Exchange Board of India" payable at

New York

Q12. How many days it takes to get registered as FII?

Answer. SEBI generally takes seven working days in granting FII registration. However,

in cases where the information furnished by the applicants is incomplete, seven days

shall be counted from the days when all necessary information sought, reaches SEBI.

In cases where the applicant is bank and subsidiary of a bank, SEBI seeks comments

from the Reserve Bank of India (RBI). In such cases, 7 working days would be counted

from the day no objection is received from RBI.

Q13. What is the validity period of FII registration?

Answer. The FII registration is valid for 5 years. After expiry of 5 years, the registration

needs to be renewed.

Q14. What is the process of renewal?

Answer. It is same as registration process. Along with "Form A" and all the relevant

documents, the applicants are required to fill in additional form (Annexure 1) while

applying for renewal.

Q15. Is there any renewal fee?

Answer. Yes, US $ 5,000 needs to be paid for renewal of FII registration.

Q16. When the application for renewal should be submitted

Answer. Three months before expiry of the FII registration.

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Q17. What are 100 % debts FIIs/sub-accounts, and what is the process for their

registration?

Answer. 100 % debt FIIs are debt dedicated FIIs which invest in debt securities only. The

procedure for registration of FII/sub-account, under 100% debt route is similar to that of

normal funds besides a clear statement by the applicant that it wishes to be registered as

FII/sub-account under 100% debt route.

Q18. Where the application for FII registration should be sent?

Answer. The FII registration application should be sent to:

Securities and Exchange Board of India

Division of FII & Custodian

Mittal Court "B" Wing, First Floor

224, Nariman Point

Mumbai 400 021, India

Note: In case the applicant is a ‘Bank’ or "Subsidiary of a Bank" then the application

form and relevant documents need to be submitted in duplicates.

Sub-account registration:

Q19. Who can get registered as sub-account?

Answer.

A. Institution or funds or portfolios established outside India, whether incorporated

or not.

B. Proprietary fund of FII

C. Foreign Corporate

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D. Foreign Individuals

Q20. Who need to apply for sub-account registration?

Answer. The FII should apply on the behalf of the Sub-account. Both the FII and the

Sub-account are required to sign the Sub-account application form.

Q21. Which form needs to be filled when applying for sub-account registration?

Answer. "Annexure B" to "Form A" (FII application form).

Q22. What documents need to be sent with Annexure A?

Answer. None

Q23. How much is the fee for sub-account registration?

Answer. US $ 1,000

Q24. When is the registration fee payable?

Answer. At the time of submitting the application forms.

Q25. What is the mode of payment?

Answer. Demand Draft in the name of "Securities and Exchange Board of India" payable

at New York

Q26. How many days it takes to get a sub-account registered?

Answer. SEBI generally takes three working days in granting FII registration. However,

in cases where the information furnished by the applicants is incomplete, three days shall

be counted from the days when all necessary information sought, reaches SEBI.

Q27. What is the validity period of sub-account registration?

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Answer. The validity of sub-account registration is co-terminus with the FII registration

under which it is registered.

Q28. What is the process of renewal of sub-account?

Answer. It is same as initial registration.

Q29. Is there renewal fee?

Answer. Yes, US $ 1,000

Q30. Can OCBs / NRIs permitted to get registered as FII/sub-account?

Answer. No, they are not permitted.

Post-Registration Processes:

Q31. What is the procedure in case the FII/sub-account changes its name?

Answer. If a registered FII/sub-account undergoes name change, then the FII need to

promptly inform SEBI about the change. It should also mention the reasons for the name

change and give an undertaking that there has been no change in beneficiary ownership.

In case of name change of FII, the request should be accompanied with documents from

home regulator and registrar of the company evidencing approval of name change, and

the original FII registration certificate issued by SEBI should be sent back for necessary

amendment.

Q32. What is the procedure for transferring a sub-account from one FII to another?

Answer. The FII to whom the Sub-account is proposed to be transferred has to send a

request along with a declaration that it is authorized to invest on behalf of the Sub-

account. The transferor FII should also submit a No-objection certificate.

Q33. What is the procedure for change of domestic custodian?

33


Answer. The FII should send a request, along with no-objection certificate from existing

domestic custodian, for change in domestic custodian.

Q34. Can FII/sub-account registration be cancelled on request?

Answer. Yes, the FII would be required to send a request for cancellation of its

registration or registration of its Sub-account/s clearly mentioning the name and

registration number of the entity. The FII should ensure that it / Sub-account has nil

cash / securities holdings.

Q35. What if the FII does not renew its/sub-account’s registration?

Answer. The registration of the FII / Sub-account would get expired at due date and it

would not be allowed to trade in Indian securities markets. If it is not interested in

renewal but has certain residual assets, it can apply for disinvestment in terms of Circular

No. FITTC/CUST/12/2001 dated June 04, 2001 and abides by the guidelines specified in

this regard.

Investment Opportunities:

Q36. Which financial instruments are available for FII investments?

Answer.

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.

Q37. What are the investment limits on equity investments by FII/sub-account?34

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Answer.

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.

Q38. What are the investment limits on debt investments by FII/sub-account?

Answer. 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:

100 % Debt Route US $ 1.55 billion

70 : 30 Route US $ 200 million

Total Limit US $ 1.75 billion

For corporate debt the investment limit is fixed at US $ 500 million.

Q39. What other investment limits are there?

Answer.

Normal FII (70:30 Route) 100% Debt FII

35


Total investment in equity and equity related

instruments shall not be less than 70% of aggregate

of all investments.

100% investment shall be made in debt

security only.

Q40. In whose name should the securities be registered?

Answer.

A. In the name of FII when making investments on its own behalf

B. In the name of sub-account when making investments on behalf of Sub-account

C. In the name of "FII a/c sub-account" when making investments on behalf of Sub-

account.

Derivatives Position Limits:

Q41. What are the restrictions on investment in derivatives?

Answer.

A. The FII position limits in a derivative contracts (Individual Stocks)

The FII position limits in a derivative contract on a particular underlying stock i.e. stock

option contracts and single stock futures contracts are:

For stocks in which the market wide position limit is less than or equal to Rs. 250 Cr,

the FII position limit in such stock shall be 20% of the market wide limit.

For stocks in which the market wide position limit is greater than Rs. 250 Cr, the FII

position limit in such stock shall be Rs. 50 Cr.

B. FII Position limits in Index options contracts

36


FII position limit in all index options contracts on a particular underlying index shall be

Rs. 250 Cr or 15 % of the total open interest of the market in index options, whichever is

higher, per exchange.

This limit would be applicable on open positions in all option contracts on a particular

underlying index.

C. FII Position limits in Index futures contracts:

FII position limit in all index futures contracts on a particular underlying index shall be

Rs. 250 Cr or 15 % of the total open interest of the market in index futures, whichever is

higher, per exchange.

This limit would be applicable on open positions in all futures contracts on a particular

underlying index.

In addition to the above, FIIs shall take exposure in equity index derivatives subject to

the following limits:

Short positions in index derivatives (short futures, short calls and long puts) not

exceeding (in notional value) the FII’s holding of stocks.

Long positions in index derivatives (long futures, long calls and short puts) not

exceeding (in notional value) the FII’s holding of cash, government securities, T-Bills

and similar instruments.

D. FII Position Limits in Interest rate derivative contracts

At the level of the FII

The notional value of gross open position of a FII in exchange traded interest rate

derivative contracts shall be:

US $ 100 million.

In addition to the above, the FII may take exposure in exchange traded in interest rate

derivative contracts to the extent of the book value of their cash market exposure in

Government Securities.

37


At the level of the sub-account

The position limits for a Sub-account in near month exchange traded interest rate

derivative contracts shall be higher of:

Rs. 100 Cr

15% of total open interest in the market in exchange traded interest rate derivative

contracts.

Offshore Derivatives/Participatory Notes:

Q42. Can FII/sub-account issue Offshore Derivatives / Participatory Notes?

Answer. Yes, FII/sub-account may issue, deal in or hold off-shore derivative instruments

such as Participatory Notes, Equity Linked Notes or any other similar instruments against

underlying securities, listed or proposed to be listed on any stock exchange in India.

Q43. Who can subscribe to/invest in Participatory Notes?

Answer.

A. Any entity incorporated in a jurisdiction that requires filing of constitutional

and/or other documents with a registrar of companies or comparable regulatory agency or

body under the applicable companies legislation in that jurisdiction;

B. Any entity that is regulated, authorised or supervised by a central bank, such as

the Bank of England, the Federal Reserve, the Hong Kong Monetary Authority, the

Monetary Authority of Singapore or any other similar body provided that the entity must

not only be authorised but also be regulated by the aforesaid regulatory bodies;

C. Any entity that is regulated, authorised or supervised by a securities or futures

commission, such as the Financial Services Authority (UK), the Securities and Exchange

Commission (Sub-account), the Commodities Futures Trading Commission (Sub-

account), the Securities and Futures Commission (Hong Kong or Taiwan), Australian

38


Securities and Investments Commission (Australia) or other securities or futures

authority or commission in any country , state or territory ;

D. Any entity that is a member of securities or futures exchanges such as the New

York Stock Exchange (Sub-account), London Stock Exchange (UK), Tokyo Stock

Exchange (Japan), NASD (Sub-account) or other similar self-regulatory securities or

futures authority or commission within any country, state or territory provided that the

aforesaid mentioned organizations which are in the nature of self regulatory

organizations are ultimately accountable to the respective securities / financial market

regulators.

E. Any individual or entity (such as fund, trust, collective investment scheme,

Investment Company or limited partnership) whose investment advisory function is

managed by an entity satisfying the criteria of (A), (B), (C) or (D) above.

Q44. What are the reporting Requirements for the FII / Sub-account issuing Participatory

Notes?

Answer.

A. FII/sub-account who issue/renew/cancel/redeem PNs, require to report on

Monthly basis. The report should reach SEBI by the 7th day of the following month.

B. The FII/sub-account merely investing/subscribing in/to the Participatory

Notes/Access Products/Offshore Derivative Instruments or any such type of

instruments/securities with underlying Indian market securities are required to report on

quarterly basis (Jan-Mar, Apr-Jun, Jul-Sep and Oct-Dec).

C. FIIs/sub-accounts who do not issue PNs but have trades/holds Indian securities

during the reporting quarter (Jan-Mar, Apr-Jun, Jul-Sep and Oct-Dec) require to submit

'Nil' undertaking on a quarterly basis.

D. FIIs/sub-accounts who do not issue PNs and do not have trades/ holdings in

Indian securities during the reporting quarter. (Jan-Mar, Apr-Jun, Jul-Sep and Oct-Dec):

No reports required for that reporting quarter.

Q45. How to send report on Participatory Notes?

39


Answer.

A. The format for reporting on issuance/ renewal / redemption of the Participatory

Notes is prescribed as per "Annexure B" in our Circular No. IMD/CUST/15/2004 dated

April 02, 2004.

B. The reports should be e-mailed only to SEBI.

C. In case of Nil-reports, ‘Annexure B’ is not required. Instead the FII on behalf

of its Sub-account should submit the undertaking prescribed in our circular No.

IMD/CUST/9/2003 dated November 20, 2003.

D. The reporting should be done in MS Excel format only.

40


5.7 Regulations

Investments by FIIs are regulated under SEBI (FII) regulations, 1995 and regulations

5(2) of FEMA Notification No. 20 dated May 3, 2000.

SEBI acts as the nodal point in the entire process of FII registration. FIIs are required to

apply to SEBI in a common application form in duplicate. A copy of application form is

sent by SEBI to RBI along with their ‘No Objection’ so as to enable RBI to grant

necessary permission under FEMA. RBI approval under FEMA enables an FII to buy/sell

securities on stock exchanges and open foreign currency and Indian rupee accounts with

a designated bank branch.

FIIs are required to allocate their investment between equity and debt instruments in the

ratio of 70:30. However, it is also possible for an FII to declare it a 100% debt FII in

which case it can make its entire investment in debt instruments.

FIIs can invest in listed and unlisted securities including shares, debt instruments, dated

government securities and treasury bills. No individual FII/sub-accounts taken together

acquires more than 24% of the paid up capital of an Indian company.

Indian companies can raise the above mentioned 24% ceiling to the sectoral cap /

statutory ceiling as applicable by passing a resolution by its board of directors followed

by passing a resolution to that effect by its general body in terms of press release dated

September 20, 2001 and FEMA Notification No. 45 dated September, 20, 2001.

Foreign Institutional Investors (FIIs), Non-Resident Indians (NRIs), and Persons of

Indian Origin (PIOs) are allowed to invest in the primary and secondary capital markets

in India through the portfolio investment scheme (PIS). Under this scheme, FIIs/NRIs

can acquire shares/debentures of Indian companies through the stock exchanges in India.

The ceiling for overall investment for FIIs is 24 per cent of the paid up capital of the

Indian company and 10 per cent for NRIs/PIOs. The limit is 20 per cent of the paid up

capital in the case of public sector banks, including the State Bank of India.

The ceiling of 24 per cent for FII investment can be raised up to sectoral cap/statutory

ceiling, subject to the approval of the board and the general body of the company passing

a special resolution to that effect. And the ceiling of 10 per cent for NRIs/PIOs can be

41


raised to 24 per cent subject to the approval of the general body of the company passing a

resolution to that effect.

The ceiling for FIIs is independent of the ceiling of 10/24 per cent for NRIs/PIOs.

The equity shares and convertible debentures of the companies within the prescribed

ceilings are available for purchase under PIS subject to:

The total purchase of all NRIs/PIOs both, on repatriation and non-repatriation basis,

being within an overall ceiling limit of (a) 24 per cent of the company's total paid up

equity capital and (b) 24 per cent of the total paid up value of each series of convertible

debenture; and

The investment made on repatriation basis by any single NRI/PIO in the equity shares

and convertible debentures not exceeding five per cent of the paid up equity capital of the

company or five per cent of the total paid up value of each series of convertible

debentures issued by the company

Monitoring foreign investments:

The Reserve Bank of India monitors the ceilings on FII/NRI/PIO investments in Indian

companies on a daily basis. For effective monitoring of foreign investment ceiling limits,

the Reserve Bank has fixed cut-off points that are two percentage points lower than the

actual ceilings. The cut-off point, for instance, is fixed at 8 per cent for companies in

which NRIs/ PIOs can invest up to 10 per cent of the company's paid up capital. The cut-

off limit for companies with 24 per cent ceiling is 22 per cent and for companies with 30

per cent ceiling, is 28 per cent and so on. Similarly, the cut-off limit for public sector

banks (including State Bank of India) is 18 per cent.

Once the aggregate net purchases of equity shares of the company by FIIs/NRIs/PIOs

reach the cut-off point, which is 2% below the overall limit, the Reserve Bank cautions

all designated bank branches so as not to purchase any more equity shares of the

respective company on behalf of FIIs/NRIs/PIOs without prior approval of the Reserve

Bank. The link offices are then required to intimate the Reserve Bank about the total

number and value of equity shares/convertible debentures of the company they propose

to buy on behalf of FIIs/NRIs/PIOs. On receipt of such proposals, the Reserve Bank

gives clearances on a first-come-first served basis till such investments in companies

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reach 10 / 24 / 30 / 40/ 49 per cent limit or the sectoral caps/statutory ceilings as

applicable. On reaching the aggregate ceiling limit, the Reserve Bank advises all

designated bank branches to stop purchases on behalf of their FIIs/NRIs/PIOs clients.

The Reserve Bank also informs the general public about the `caution’ and the `stop

purchase’ in these companies through a press release.

43


5.8 Guidelines for investment by foreign institutional investors

Foreign Institutional Investor (FIIs) are both feared and loved on Mumbai Dalal Street,

home to the stock exchange. Loved because when they come, stock soars and investors

rejoice. Feared because when do they leave, the stock market collapses, smoothing in its

debris millions of investor.

While presenting the Budget for 1992-93, the Finance Minister Dr. Manmohan Singh had

announced a decision to allow reputed foreign investors, such as Pension Funds etc., to

invest in India capital market. To operationalize this policy announcement, it has become

necessary to evolve guidelines for such investments by Foreign Institutional Investors

(FIIs).

The following guidelines have been formulated in this regard

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)

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 may 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 guidelines. Nominee companies, affiliates

and subsidiary companies of a FII will be treated as separate FIIs for registration, and

may seek separate registration with SEBI.

44


4. Since there are foreign exchange controls also in force, for various permissions

under exchange control, along with their application for initial registration, FIIs shall also

file with SEBI another application addressed to RBI for seeking various permissions

under FERA, in a format that would be specified by RBI for this 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 shall 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 shall be required to hold a registration from the Securities

Commission, or the regulatory organisation 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 will also hold good for five years. Both will 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 realise capital gains on investments made through initial corpus remitted to

India, subscribe/renounce rights offerings of shares, invest on all recognised stock

exchanges through a designated bank branch, and to appoint a domestic Custodian for

custody of investments held.

8. This General Permission from RBI shall also enable the FII to:

a. Open foreign currency denominated accounts in a designated bank. (There can

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;

45


d. Make investments in the securities in India out of the balances in the rupee

account;

e. Transfer repatriable (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

authorised to deduct with holding 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

maximum-for 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 is 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 will be subject to a ceiling

of 30% of issued share capital for the total holdings of all registered FIIs, in any one

company. The ceiling would apply 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 will 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, will also include NRI corporate and non-corporate

investments, but will not include the following:

a. Foreign investments under financial collaborations (direct foreign investments),

which are permitted upto 51% in all priority areas.

b. Investments by FIIs through the following alternative routes:

46


i. offshore single/regional funds;

ii. Global Depository Receipts;

iii. Euro convertibles

12. Disinvestment will be allowed only through stock exchange in India, including

the OTC Exchange. In exceptional cases, SEBI may permit sales other than through stock

exchanges, provided the sale price is not significantly different from the stock market

quotations, where available.

13. All secondary market operations would be only through the recognised

intermediaries on the Indian Stock Exchange, including OTC Exchange of India. A

registered FII would be expected not to engage in any short selling in securities and to

take delivery of purchased and give delivery of sold securities.

14. A registered FII can appoint as Custodian an agency approved by SEBI to act as

custodian of Securities and for confirmation of transactions in Securities, settlement of

purchase and sale, and for information reporting. Such custodian shall establish separate

accounts for detailing on a daily basis the investment capital utilisation and securities

held by each FII for which it is acting as custodian. The custodian will report to the RBI

and SEBI semi-annually as part of its disclosure and reporting guidelines.

15. The RBI shall make available to the designated bank branches a list of

companies where no investment will be allowed on the basis of the upper prescribed

ceiling of 30% having been reached under the portfolio investment scheme.

16. Reserve Bank of India may at any time request by an order a registered FII to

submit information regarding the records of utilisation of the inward remittances of

investment capital and the statement of securities transactions. Reserve Bank of India

and/or SEBI may also at any time conduct a direct inspection of the records and

accounting books of a registered FII.

17. FIIs investing under this scheme will benefit from a concessional tax regime of a

flat rate tax of 20% on dividend and interest income and a tax rate of 10% on long term

(one year or more) capital gains.

47


The stock market rose sharply and the Sensex crossed the all-time high of 17,000 after

the 0.5 percent rate cut announced by the US Federal Reserve on September 18 ‘2007’.

Foreign institutional investors (FII) invested more than USD 1.5 billion in the domestic

stock markets after September 18 itself and the total FII investments this year has crossed

USD 11 billion.

48


5.9 6RBI Guidelines for FII Investment

(In dated government securities-RBI press release: March 8, 1997)

As a sequel to the government’s decision to permit foreign institutional investors (FII’s)

to invest in dated government securities, the reserve bank of India has announced the

following guidelines for FII’s authorized to invest in dated government securities.

For the purpose of FII investment, dated government securities would include dated

securities of both government of India and state governments of all maturities, but would

not include treasury bills.

Investment in dated government securities by FIIs may be made either in the primary

market at the auction/floatation or in the secondary market.

Investment in dated government securities by FIIs should be undertaken only through

designated banks, i.e. any bank in India which has been authorized by the Reserve bank

to act as a banker to Foreign Institutional Investors.

Investment by FIIs will be allowed only in the form of subsidiary general ledger

(SGL) account through a bank having both SGL Account no. II (Constituents’ Account)

and current Accounts with the reserve bank of India.

The secondary market transactions by FIIs will be permitted through recognized

Indian stock exchanges or over the counter with SGL Account holders and will be

governed by the delivery versus payment system of the Reserve bank of India.

6 Press Note dated 14th Sept. 1992 of Department of Economic Affairs, (Investment Division), Ministry

of Finance

49


5.10 7Investment in Indian Companies by FIIs/NRIs/PIOs:

The current list of companies allowed to attract investments from FIIs/NRIs/PIOs with their respective ceilings is

Companies in which NRIs/PIOs investment is allowed up to 24% of their Paid-up Capital

1. Alembic Chemical Works Co. Ltd

2. Amar Investments Ltd, Calcutta.

3. Anglo-India Jute Mills Co.Ltd

4. Arvind Mills, Ahmedabad

5. Ashima Syntex Ltd, Ahmedabad

6. Ashoka Viniyoga Ltd

7. Bharat Nidhi Ltd

8. BLB Shares & Financial Services Ltd

9. BPL Ltd

10. Burr Brown (India) Ltd

11. Camac Commercial Company Ltd

12. Ceenik Exports (India) Ltd

13. Cifco Finance Ltd, Mumbai

14. Classic Financial Services & Enterprises Ltd, Calcutta

15. CPPL Ltd,(Reliance Ind. Infrastructure Ltd), Mumbai

7 http://www.rbi.org.in/advt/FIINRI.html

50


16. CRISIL

17. DCM Shriram Consolidated Ltd

18. Dharani Sugars & Chemicals Ltd.

19. Dolphin Offshore Enterprises (I) Ltd

20. Essar Oil Ltd

21. Essar Shipping Ltd, Bangalore

22. Essar Steel Ltd

23. Eveready Industries India Ltd

24. Fabworth (I) Ltd

25. Ferro Alloys Corporation Ltd, Tumsar

26. Global Tele Systems Ltd

27. Grasim Industries Ltd

28. Hamco Mining & Smelting Ltd

29. Hindustan Development Corp Ltd, Calcutta

30. Hindusthan Nitroproducts (Gujrat) Ltd

31. Hindustan Transmission Products Ltd, Mumbai

32. HMG Industries Ltd, Mumbai

33. India Securities Ltd

34. IVP Ltd.

35. Jagatjit Industries Ltd, New Delhi

51


36. Jai Parabolic Springs Ltd, New Delhi

37. Jaysynth Dyechem Ltd

38. Jindal Strips Ltd

39. Jindal Iron & Steel Co.Ltd

40. JJ Spectrum Silk Ltd

41. Kartjikeya Paper & Boards Ltd

42. Lakhani India Ltd

43. Matsushita Television And Audio India Ltd

44. M.P.Agro Fertilisers Ltd, Bhopal

45. Macleod Russel (I) Ltd,

46. Mazda Enterprises Ltd,Mumbai

47. Media Video Ltd

48. Multimetals Ltd, Mumbai

49. National Steel Industries Ltd

50. Nicholas Laboratories India Ltd, Mumbai

51. O.P. Electronics Ltd, Mumbai

52. Oriental Housing Development Finance Corp Ltd

53. Padmini Technologies Ltd

54. Panacea Biotech Ltd.

55. Pearl Polymers Ltd, New Delhi

52


56. Piramal Healthcare Ltd

57. PNB Finance & Industries Ltd

58. Rajath Leasing & Finance Ltd

59. Rama Petrochemicals Ltd.

60. Rama Phosphates Ltd.

61. Reliance Industries Ltd, Mumbai

62. Rishra Investment Ltd, Calcutta

63. Rossell Industries Ltd, Calcutta

64. Sahu Properties Ltd

65. Sanghvi Movers Ltd

66. Saurashtra Paper & Board Mills Ltd

67. Saw Pipes Ltd

68. Sayaji Hotel Ltd

69. Sharyans Resources Ltd

70. Shrenuj & Company Ltd

71. Shibir India Ltd, Calcutta

72. Shriram Industries Enterprises Ltd,N.Delhi

73. Silverline Industries Ltd

74. Sonata Software Ltd

75. SRF Ltd

53


76. Sterling Lease Finance Ltd, Mumbai

77. Svam Software Ltd

78. Synthetics and Chemicals Ltd,Mumbai

79. The Champdany Industries Ltd, Calcutta

80. The Dharamsi Morarji Chemical Company Ltd

81. The Investment Trust of India Ltd

82. The Morarjee Goculdas Spinning & Weaving Company Ltd,Mumbai

83. Tolani Bulk Carrier Ltd

84. Uniworth International Ltd

85. Valecha Engineering Ltd

86. VisualSoft Technologies Ltd

87. Weltermann International Ltd

88. Woolworth (India) Ltd

89. Zora Pharma Ltd

Companies in which NRIs/PIOs investment is allowed up to 17% of their Paid-up

Capital

Garware Shiping Corporation Ltd.

Companies where NRI investment has reached 8% and further purchases are allowed only with prior approval RBI

1. Astra IDL Ltd.

2. M/s. Codura Exports Ltd.

54


3. IDL Industries Ltd.

4. Nexus Software Ltd.

5. Dalmia Cement (Bharat) Ltd.

Companies where NRI investment has already reached 10% and no further purchases

can be allowed

1. DSQ Biotech Ltd

2. Global Trust Bank Ltd.

3. Madras Aluminium Co. Ltd

4. SPL Ltd

5. Seirra Optima Ltd

6. The Baroda Rayon Corp

7. Tai Industries Ltd.

Companies where NRI investment has already reached 22% and no further purchases

can be allowed

None

Companies in which FII Investment is allowed up to 30% of their paid up capital

1. Aptech Ltd

2. Asian Paints (India) Ltd

3. Capital Trust Ltd

4. Container Corporation of India

5. Ferro Alloys Corporation Ltd

55


6. Garware Polyester Ltd

7. GIVO Ltd (formerly KB&T Ltd)

8. Gujarat Ambuja Cements Ltd

9. Infotech Enterprises Ltd.

10. Mastek Ltd

11. Orchid Chemicals and Pharmaceuticals Ltd

12. Pentasoft Technologies Ltd (Pentafour Communications Ltd)

13. Polyplex Corporation Ltd

14. Ranbaxy Laboratories Ltd

15. Software Solutions Integrated Ltd

16. Sonata Software Ltd

17. The Credit Rating Information Services of India Ltd.

18. The Paper Products Ltd

19. Vikas WSP Ltd


1. Balaji Telefilms Ltd.

2. M/s. Burr Brown (India) Ltd.

3. M/s. Elbee Services Ltd.

4. Hero Honda Motors Ltd.

5. Jyoti Structures Ltd

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6. Maars Software International Ltd.

7. Padmini Technologies Ltd

8. Pentamedia Graphics Ltd.

9. Thiru Arooran Sugars Ltd.

10. UTV Software Ltd.

11. VisualSoft Technologies Ltd

12. M/s. Silverline Technologies Ltd.

13. Ways India Ltd

14. SSI Ltd


1. Blue Dart Express Ltd

2. CRISIL

3. HDFC Bank Ltd

4. Hindustan Lever Ltd

5. Himachal Futuristic Communications Ltd

6. Infosys Technologies Ltd.

7. NIIT Ltd.

8. Dr. Reddy's Laboratories

57


9. Panacea Biotec Ltd

10. Reliance Industries Ltd.

11. Reliance Petroleum Ltd.

12. Sofia Software Ltd

13. Sun Pharmaceutical Industries Ltd

14. United Breweries Ltd.

15. United Breweries (Holdings) Ltd.

16. Zee Telefilms Ltd.

Companies in which NRI/FII Investment is allowed upto 49% of their paid up capital

ICICI Bank Ltd.

Companies in which FII Investment is allowed up to sectoral cap/statutory ceiling of

their paid up capital

1. GTL Ltd. - (74%)

2. Housing Development Finance Corporation Ltd. - (74%)

3. Infosys Technologies Ltd. - (100%)

4. Pentamedia Graphics Ltd. - (100%)

5. Pentasoft Technologies Ltd. - (100%)

6. Mascon Global Ltd. - (100%)

7. Punjab Tractors Ltd. - (64%)

8. Satyam Computer Services Ltd - (60%)

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Companies where 22% FII investment limit has been reached and further purchases

are allowed with prior approval of RBI

1. ACC Ltd.

2. Digital GlobalSoft Ltd.

Companies where 28% FII investment limit has reached and further purchases are

allowed with prior approval of RBI

None

Companies where 38% FII investment limit has reached and further purchases are

allowed with prior approval of RBI

None

Companies in which the Caution limit (47%) in respect of maximum permissible

foreign holding including NRI/PIO/FII Investment as stipulated by Government has been

reached

None

Companies where 49% limit has been reached and no further purchases will be

allowed

None

Public Sector banks including SBI in which 18% limit has been reached.

None

Public Sector banks including SBI in which 20% limit has been reached.

State Bank of India

Companies falling under 24% and 30%

59


None

Companies in which the Ban limit in respect of maximum permissible foreign holding

including GDR/ADR/FDI/NRI/PIO/FII Investment as stipulated by Government has

been reached

1. ICICI Ltd.

Companies in which the Caution limit (47%) in respect of maximum permissible

foreign holding including GDR/ADR/FDI/NRI/PIO/FII Investments as stipulated by

Government has reached

None

60


CHAPTER 6 - FEATURES AND REASONS FOR FII INVESTMENT

61


6.1 Attractive features for FII investment

There are several good reasons for investing in India

One of the largest economies in the world.

Strategic location - access to the vast domestic and South Asian market.

A large and rapidly growing consumer market up to 300 million people, constitute the

market for branded consumer goods - estimated to be growing at 8% per annum. Demand

for several consumer products is growing at over 12% per annum.

Foreign investment is welcome; approval is required but is automatic in sixty

categories of Industries.

Skilled man-power and professional managers are available at competitive cost.

One of the largest manufacturing sectors in the world, spanning almost all areas of

manufacturing activities.

One of the largest pools of scientists, engineers, technicians and managers in the

world.

Rich base of mineral and agricultural resources.

Long history of market economy infrastructure

Sophisticated financial sector.

Vibrant capital market with over 9,000 listed companies and market capitalisation of

US$ 154 billion (March,1996)

Well developed R&D infrastructure and technical and marketing services.

Policy environment that provides freedom of entry, investment, location, choice of

technology, production, import and export.

Well balanced package of fiscal incentives.

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A sophisticated legal and accounting system.

English is widely spoken and understood.

Rupee is convertible on Current Account at market determined rate.

Free and full repatriation of capital, technical fee, royalty and dividends.

Foreign brand names are freely used.

No income tax on profits derived from export of goods.

Complete exemption from Customs Duty on industrial inputs and Corporate Tax

Holiday for five years for 100 per cent Export Oriented units and units in Export

Processing Zones.

Corporate Tax applicable to the foreign companies of a country, with which

agreement for avoidance of Double Taxation exists, can be one which is lower between

the rates prevailing in any one of the two countries and the treaty rate.

A long history of stable parliamentary democracy.

In addition to reason that they can influence the market, there are many factors in India

that their favor. Things like our strong GDP growth, our companies that show global

standards, the long-term outlook on the dollar and interest rates in the US. Out of all

these there is one big advantage, which India has that other developing nations lack that

is our world-class financial system. Indian capital markets are technologically

comparable to any advanced market. We have all the modern financial instruments like

derivatives, commodity derivatives, stable forex market etc.

Growth in the economy: The Indian economy is second fastest-growing economy in the

world. It is growing at around eight percent from the last five years and at around six

percent from the last 10 years.

Growth of businesses: The fast growth in the economy resulted in a dramatic growth in

businesses. Thus, the returns that FIIs get in India are quite good.

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Easy registration: India has reduced a lot of procedural bottlenecks for FIIs to register.

Fairly simple Securities and Exchange Board of India (SEBI) registration and some other

formalities are all it takes before an FII can enter the domestic stock market and start

trading. The procedure to exit is also quite simple.

Favourable environment: Due to a positive environment in India, the number of FIIs

registered with the SEBI has now gone up to more than 1,000 (the number was around

800 a year ago).

Saturation in global economies: Economies in developed countries are growing at a

stable rate of 2-3 percent per annum, and hence provide lesser opportunities.

Dollar rate: Weakness in the US dollar (due to increasing current account deficit in the

US, problems due to crisis in sub-prime market etc) has prompted foreign investors to

reduce exposure to dollar investments.

FII activity has increased the volatility and valuation of domestic companies significantly

in the last couple of years. FII fund inflows into the markets have seen major re-rating on

price-to-earning from the 2003 levels. Prior to 2003, the Sensex price-to-earning ratio

used to be around 12-13. It has now gone up by about 20 times. The uptrend seen in the

domestic markets in the last 3-4 years can be directly linked to FII inflows.

These are some of the factors that FIIs look for while investing in various companies and

sectors:

Credit rating: FIIs look for companies with good credit ratings. Studies say that

generally, FIIs maintain investments in almost all index (BSE and NSE) companies.

Outlook of company: FIIs have a good team of analysts. They analyse various financial

parameters of companies before selecting a company to investment in. They also analyse

the overall outlook of the sector in which the company is operating. For example,

companies operating in sectors like telecom, banking, real estate etc.

Management of company: FIIs look for market position and potential of companies.

They also look at the management and leadership of the company.

64


FII inflows have been the major drivers of liquidity and volatility in the domestic

markets. Due to FIIs being active, the markets see huge upward moves on any positive

news on the global front and also quick reactions to any adverse news. Growth in the

local mutual funds' kitty is seen as a cushion against FII movements, but given the

momentum of the FII movements, volatility in the markets is still seen. In a nutshell, FIIs

have magnified the overall volatility (rate of upward and downward movements) in the

domestic markets

To sum it up, we have a technologically and functionally advanced financial system,

which is reliable and safe in addition to a good macro-economic environment, which

could be influenced by FIIs. What more would the FIIs as for. Even we have our big

Indian growth story the main reason, which drives the FIIs to India, is their ability to

influence Indian markets, as they want.

65


6.2 Reasons for FIIs inflow in Indian market

Indian GDP growth rate moving ahead will be 7-8%.

India will move ahead and China will get a slow down.

Fair Valuation and better corporate governance will further catch FII's attention

The next Infrastructure boom, high consumption and outsourcing will accelerate the

growth story and will change the Indian picture in the world table.

Dollar would decline over the period to come.

Huge expansions by almost all the big and mid size companies will further add the

market cap of the BSE and NSE.

VAT a great measure for Indian Government has joined the list of 130 vat

implemented countries. This is bringing more revenue.

6.3 Reasons for FIIs outflow in Indian market

Political uncertainty, if any arises.

Review of Fringe benefits tax and cash withdrawal tax to be revisited as this may

affect Company's bottom line in cascading tax way.

66


6.4 8Benefits and costs of FII investments:

The terms of reference asking the Expert Group to consider how FII inflows can be

encouraged and examine the adequacy of the existing regulatory framework to

adequately address the concern for reducing vulnerability to the flow of speculative

capital do not include an examination of the desirability of encouraging FII inflows. Yet,

for motivating the consideration of the policy options, it is useful to briefly summarize

the benefits and costs for India of having FII investment. Given the Group’s mandate of

encouraging FII flows, the available arguments that mitigate the costs have also been

included under the relevant points.

BENEFITS:

Reduced cost of equity capital: FII inflows augment the sources of funds in the Indian

capital markets. In a commonsense way, the impact of FIIs upon the cost of equity capital

may be visualized by asking what stock prices would be if there were no FIIs operating

in India. FII investment reduces the required rate of return for equity, enhances stock

prices, and fosters investment by Indian firms in the country.

Imparting stability to India's Balance of Payments: For promoting growth in a

developing country such as India, there is need to augment domestic investments, over

and beyond domestic saving, through capital flows. The excess of domestic investment

over domestic savings result in a current account deficit and this deficit is financed by

capital flows in the balance of payments. Prior to 1991, debt flows and official

development assistance dominated these capital flows. This mechanism of funding the

current account deficit is widely believed to have played a role in the emergence of

balance of payments difficulties in 1981 and 1991. Portfolio flows in the equity markets,

and FDI, as opposed to debt-creating flows, are important as safer and more sustainable

mechanisms for funding the current account deficit.

Knowledge flows: The activities of international institutional investors help strengthen

Indian finance. FIIs advocate modern ideas in market design, promote innovation,

8http://www.articlesbase.com/investing-articles/investment-from-abroad-is-right-or-wrong-216418.html

67


development of sophisticated products such as financial derivatives, enhance competition

in financial intermediation, and lead to pullovers of human capital by exposing Indian

participants to modern financial techniques, and international best practices and systems.

Strengthening corporate governance: Domestic institutional and individual investors,

used as they are to the ongoing practices of Indian corporate, often accept such practices,

even when these do not measure up to the international benchmarks of best practices.

FIIs, with their vast experience with modern corporate governance practices, are less

tolerant of malpractice by corporate managers and owners (dominant shareholder). FII

participation in domestic capital markets often lead to vigorous advocacy of sound

corporate governance practices, improved efficiency and better shareholder value.

Improvements to market efficiency: A significant presence of FIIs in India can

improve market efficiency through two channels. First, when adverse macroeconomic

news, such as a bad monsoon, unsettles many domestic investors, it may be easier for a

globally diversified portfolio manager to be more dispassionate about India's prospects,

and engage in stabilising trades. Second, at the level of individual stocks and industries,

FIIs may act as a channel through which knowledge and ideas about valuation of a firm

or an industry can more rapidly propagate into India. For example, foreign investors were

rapidly able to assess the potential of firms like Infosys, which are primarily export-

oriented, applying valuation principles that prevailed outside India for software services

companies.

COSTS:

Herding and positive feedback trading: There are concerns that foreign investors are

chronically ill-informed about India, and this lack of sound information may generate

herding (a large number of FIIs buying or selling together) and positive feedback trading

(buying after positive returns, selling after negative returns). These kinds of behavior can

exacerbate volatility, and push prices away from fair values. FIIs’ behavior in India,

however, so far does not exhibit these patterns. Generally, contrary to ‘herding’, FIIs are

seen to be involved in very large buying and selling at the same time.

BoP vulnerability: There are concerns that in an extreme event, there can be a massive

flight of foreign capital out of India, triggering difficulties in the balance of payments

68


front. India's experience with FIIs so far, however, suggests that across episodes like the

Pokhran blasts, or the 2001 stock market scandal, no capital flight has taken place. A

billion or more of US dollars of portfolio capital has never left India within the period of

one month. When juxtaposed with India's enormous current account and capital account

flows, this suggests that there is little evidence of vulnerability so far.

Possibility of taking over companies: While FIIs are normally seen as pure portfolio

investors, without interest in control, portfolio investors can occasionally behave like FDI

investors, and seek control of companies that they have a substantial shareholding in.

Such outcomes, however, may not be inconsistent with India's quest for greater FDI.

Furthermore, SEBI's takeover code is in place, and has functioned fairly well, ensuring

that all investors benefit equally in the event of a takeover.

69


6.5 Effects of FII flow on the recipient country economy

As such, FII flows to the secondary equity market do not have any direct link with the

level of real investment in the economy. It is only by enhancing the efficiency and

liquidity of capital markets that such a flow can contribute to growth. Securities markets

in developing countries are typically both narrow and shallow. Therefore, FII

participation may, a priori, induce considerable instability in these markets. The effect of

such mobile capital flows can, however, be quite complicated and therefore are highly

controversial. In fact, country experiences differ considerably. Some studies found clear

evidence of benefits of such flow in the form of equity market development, capital

market integration, lowering cost of capital, and hence tend to question policy concerns

regarding resource mobilization, market co-movements, contagion and volatility

expressed by some policy makers and academics to be largely unwarranted. The causes

of the instability and volatility of short-term portfolio capital flows to emerging markets

are often related to the way in which investment funds are managed in order to confront

uncertainty. It has been alleged that international portfolio investors seek liquidity and

use ‘quick exit’ as a means of containing downside risk, thus making frequent marginal

adjustments to their portfolios. Further, shifts in the portfolio composition of global

investors are largely ascribed to changes in their perceptions of country solvency rather

than to variations in underlying asset value. A common conclusion from research,

however, is that institutions sometimes panic, disregard fundamentals and spread crisis

even to countries with strong fundamentals. The literature also notes that individuals, too,

can contribute to this destabilisation process by fleeing from funds, particularly mutual

funds and forcing fund managers to sell when fundamentals do not warrant such sale.

Empirical results of the effect of FII activities on the volatility of return are rather

divided; some studies do not find that foreign investors have any destabilising impacts on

stock prices. Evidences to the contrary showing that foreign investors cause higher

volatility in the market compared to domestic investors or that stocks in which foreign

investors mainly trade experience higher volatility compared to those in which they do

not show much interest also exist. These studies also show that volatility caused by FII

jumped significantly around the crises period.

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6.6 FII holdings in Indian markets drops

FII ownership in Indian stock markets dropped to 15.5% — levels last seen in December

2003, which were early days of the big bull rally that climaxed in January 2008 when

Sensex the benchmark index of the Bombay Stock Exchange reached its lifetime high of

21,206.77 points.

The index saw seven-fold rise from about 3,000 points to more than 21,000 points

between 2003 and early-2008, the biggest Bull Run in its history. It ended with a 52%

slump in 2008, as global investors fled from high-risk equity assets, hit by a worldwide

financial crisis. “The (ownership) level is almost of an age gone by,” according to a mid-

February India strategy report by equity analysts at Citigroup Global Markets India Pvt.

Ltd. The value of FII ownership in Indian stocks, however, is much higher than what it

was in 2003 and estimated value at about Rs 4.84 trillion.

FIIs sold more than $13 billion worth of Indian stocks in 2008, after investing $17 billion

in 2007, betting on the decoupling theory, which said that the Indian economy will be

resilient to the outside world. The theory was proved wrong in 2008.

In 2009 so far, FIIs have sold another $2.1 billion of Indian stocks, driving the

benchmark stock index down 14%. FIIs had started a buying trend around December

2008 and early January, but the Satyam episode reversed the trend again.

B. Ramalinga Raju, chairman of Satyam Computer Services Ltd, India’s fourth largest

software exporter, on 7 January confessed to a Rs7,136 crore fraud. India’s large fiscal

deficit is seen as a big worry. FIIs could review their India strategy after the new

government takes over in June.

71


CHAPTER 7 - TRENDS OF FOREIGN INSTITUTIONAL INVESTORS

72


7.1 FII inflows from 2000 -2007

73


7.2 Trends in FII registration

YEAR NO. OF REGISTRATIONS

1993 18

1994 158

1995 308

1996 367

1997 439

1998 496

1999 450

2000 506

2001 527

2002 490

2003 502

2004 540

2005 685

2006 882

2007 1191

74


SOURCE: RESERVE BANK OF INDIA

In terms of origin, the USA topped the list with a share of 40% of the number of FIIs

registered in India, followed by UK’s 17%. Other countries of significance in terms of

origin of FIIs investing in India are Luxemburg, Hong Kong, and Singapore. In terms of

net cumulative investments by FIIs, US-based FIIs dominate with 29% of net cumulative

FII investments in India, followed by UK at 17%. In recent months, European and

Japanese FIIs have started to evince an increasing interest in India, and of the FIIs that

registered with SEBI in October 2004, a significant number belonged to Europe and

Japan. These developments have helped improve the diversity of the set of FIIs operating

in India.

75


76


7.3 9FIIs with SENSEX:

Foreign institutional investors (FII) appear to be betting in opposite directions for most of

the recent Sensex growth.

1. When Sensex jumped from 14,000 to 15,000, FII sold shares (net sales) worth 2372.10

Crores.

2. Between 15000 and 16000, FII bought shares worth Rs 7307

3. When Sensex moved from 16000 to 18000, FII bought shares worth Rs 24,372.3

Crores

4. Between 18000 and 19000, FII bought Rs 7378.2 worth shares

5. Finally, when Sensex jumped from 19000 to 20 000, FII sold (net sales) Rs 1281.1

worth of shares.

9http://ezinearticles.com/?India-Sensex-Volatility---Mutual-Funds-vs-Foreign-Institutional-

investors&id=819067

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http://ezinearticles.com/?India-Sensex-Volatility---Mutual-Funds-vs-Foreign-Institutional-investors&id=819067

http://ezinearticles.com/?India-Sensex-Volatility---Mutual-Funds-vs-Foreign-Institutional-investors&id=819067


CHAPTER 8 – ANALYSIS

78


8.1 Table of Net FII Investment and Sensex Value during 1999-2008

YearFII Net

Investment in Equity (X)

SENSEX (Y)

1999 64404 5005.822000 66786 3972.122001 124741 3262.332002 36538 3377.282003 350837 5838.962004 397072 6602.692005 492323 9397.932006 382859 13786.912007 703615 20286.992008 533097 9647.31

Table 1.1

Numbers in red are showing negative value.

Numbers in black are showing positive value.

Correlation = 0.479679669

79


8.2 Direct effects of the global crisis

The effects of the global crisis have directly impacted some important macro economic

variables. Three such indicators stand out in terms of their quite sudden deterioration

since the middle of year 2008: the decline in the foreign exchange reserves held by the

Reserve Bank of India; the fall in the external value of the rupee, especially vis-À-vis the

US dollar; and the decline in stock market indices.

Graph 1.1

Chart 1 shows how foreign exchange reserves, which had been increasingly steadily over

the past few years, started declining after June 2008. Not that the earlier build-up of

reserves reflected any great macroeconomic strength, since unlike China it was not based

on current account surpluses. Instead, the Indian economy experienced an inflow of hot

money, especially in the form of portfolio capital of FII investment.

Domestic macro policies combined with the need to prevent exchange rate appreciation

to prevent increased domestic absorption of such resources, as a result of which these

were largely added to reserves. Since they were based on hot money inflows, it was only

to be expected that they would reverse with any bad news, and that is essentially what

has happened over the past eight months, with the bad news coming from the US and

other developed markets rather than from the Indian economy.

80


Graph 1.2

But that movement of FIIs was in turn related to the sudden collapse of the rupee, shown

in Chart 2. Early in March 2009 the rupee even breached the line of Rs 51 per dollar, and

it may continue to fall. There are those who argue that this depreciation is positive since

it will help exports, but conditions prevailing in the world trade market, with falling

export volumes and values, does not give rise to much optimism in that context.

India currently has a current account deficit, including a large trade deficit and also quite

significant factor payments abroad. The falling rupee will imply rising factor payments

(such as debt repayment and profit repatriation) in rupee terms, which is not good news

for many companies or for the balance of payments.

81


Graph 1.3

Associated with all this is the evidence of falling business confidence expressed in the

stock market indicators. The Sensex, shown in Chart 3, had reached historically high

levels in the early part of 2008, capping an almost hysterical rise over the previous three

years in which it more than tripled in value. But it has plummeted since then, with high

volatility around an overall declining trend, such that its levels in early March were

below the levels attained in December 2005.

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8.3 Role of foreign investors

Graph 1.4

How much of all this is due to the behaviour of foreign investors, rather than domestic

investors? Chart 4 tracks the changes in total foreign investment, split up into direct

investment and portfolio investment, over the period since April 2007. It is evident that

both have shown a trend of increase followed by decline. FDI has been more stable with

relatively moderate fluctuations (even though it does include some portfolio-type

investments that get categorised as foreign direct investment). It peaked in February 2008

and thereafter has been coming down but is still positive.

Portfolio investment (which includes both FII investment in the domestic share market

and GDRs/ADRs) has been extremely volatile and largely negative (indicating net

outflows) since the beginning of 2008, and this has dominated the overall foreign

investment trend.

83


Graph 1.5

As a result, as Chart 5 shows, the cumulative value of the stock of Indian equity held by

FIIs fell quite sharply, by 24 per cent between May 2008 and February 2009. This is not

likely to be due to any dramatically changed investor perceptions of the Indian economy,

since if anything GDP growth prospects in India remain somewhat higher than in most

other developed or emerging markets. Rather, it is because portfolio investors have been

repatriating capital back to the US and other Northern markets.

This reflects not so much a flight to safety (for clearly US securities are not that safe

anymore either) as the need to cover losses that have been incurred in sub-prime

mortgages and other asset markets in the North, and to ensure liquidity for transactions as

the credit crunch began to bite.

84


Whatever the causes, the impact on the domestic stock market has been sharp and direct.

Since the Indian stock market is still relatively shallow, and FII activities play a

disproportionately strong role in determining the movement of the indices, it is not

surprising that this outward flow has been associated with the overall decline in stock

market valuations.

85


Graph 1.6

As Chart 6 shows, the Sensex has moved generally in the same direction as net FII

inflows. In fact, movements in the latter have been much sharper and more volatile,

suggesting that domestic investors have played a more stabilising role over this period.

86


8.4 Liberalised rules

Graph 1.7

Overall foreign investment flows (including not just FII but direct investment) have also,

predictably, played a role in determining the level of external reserves. Chart 7 shows the

pattern of aggregate net foreign investment and change in reserves since April 2007.

Once again the two move together. In this case, however, foreign investment has been

less volatile than the change in reserves, suggesting that other components of the balance

of payments have been important as well. The changes in external commercial borrowing

are likely to have been significant.

In addition, the possibilities of domestic investors moving their funds out should not be

underestimated. As the Table shows, the recently liberalised rules for capital outflow by

domestic residents have led to outflows that are not insignificant, even if still relatively

small.

Liberalised rules for capital account transactions by Indian residents seem to be

increasing the vulnerability that derives from India’s dependence on foreign investment

flows. This an aspect of India’s external payments that policy must address, especially

since there are constraints set by WTO membership on using tariffs and quantitative

restrictions on reducing foreign exchange outflows that occur on account of imports.

87


CHAPTER 9 – FINDINGS

88


9.1 Findings from Table 1.1

Graph 1.8

Graph 1.9

89


Figures in red and black shows negative and positive value respectively. These two

graphs show the trend of FIIs investment and movement of Sensex in period 1999 to

2008. Correlation value (In Table 1.1) is positive so I will accept null hypothesis Ho and

can conclude that if value of Sensex increases the net investment of FIIs also increases.

90


9.2 Impact of FIIs on the Indian Stock Markets in the near future

Buying/ Selling by FIIs: Clutching the highest number of votes (45.3%), FII activity

was seen as the key driver that could impact the Indian markets over the longer term. As

seen from the following graph, higher FII inflows have been an important parameter

determining the movement of the stock markets. In 2007, when FII invested US$ 17.2

bn, stock markets notched 46% gains. The Indian economy grew over 8% for the third

consecutive year and the prospects looked good for 2008. However in the following year,

global financial crisis clouted the world markets, with India being no exception. This led

to the FIIs turn into net sellers. The total FII disinvestment in 2008 was to the tune of

US$ 13 bn. In the same period, the benchmark BSE Sensex lost 52% of its market

capitalisation. This clearly indicates that the FIIs play a critical role. It would interest

investors to know that while the FIIs have shied away, investments through the FDI

(foreign direct investment) route have stupendously shot up in the past few months, given

the attractive valuations. This is expected to hold good for India’s long term growth

story.

India is better positioned than its developing and developed peers in terms of long term

fundamentals. It does not have a credit or a real estate bubble. It also has a large domestic

consumption market, unlike China which depends on exports. Indians have a savings rate

as high as the Chinese. These factors are expected to lure the FIIs once again to the

Indian shores. In fact, in December 2008, they were net buyers of Rs 14 bn worth of

stocks (after having sold stocks worth Rs 279 bn between August to November 2008).

The FIIs are currently holding Indian stocks worth US$ 53 bn.

91


9.3 Expectations

FIIs not to return to India before next year: Net FII outflows from the equity market

in India stood at around 8,333 million dollars since September. Foreign Institutional

Investors (FIIs), who have started selling their stocks in India sharply after the collapse of

Lehman Brothers in September, will continue to stay away in 2009, with some recovery

expected only next year, say global analytical firms.

FIIs will likely remain weak for the whole of 2009. A rebound may be seen next year

when international investors regain confidence. India will most likely start to recover in

the last quarter of the next fiscal.

During the period, there were net inflows of $433.50 million only in the month of

December in the equity market. In other months, there have been net outflows by FIIs.

Outflows of funds by FIIs have led to sharp fall in benchmark equity index Sensex since

Lehman Brothers applied for bankruptcy in the middle of September. Besides, global

gloomy economic conditions have also affected the FII inflows.

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9.4 Vulnerability to FII Flows

Strengthening domestic institutional investors: The participation of domestic funds in

the pension funds in the equity market would augment the diversity of views on the

market. This would also end the anomaly of the existing situation where foreign pension

funds are extensive users of the Indian equity market but domestic pension funds are not.

Participatory notes: The current dispensation of PNs may continue. SEBI should have

full powers to obtain information regarding the final holder/beneficiaries or of any holder

at any point of time in case of investigation or surveillance action. FIIs may be obliged to

provide the information to SEBI.

Hedge funds: Regulatory development with regard to hedge funds in the US and

elsewhere, including Europe may be closely watched to formulate policy on the basis of

experiences of these countries at a later date. Only those funds which are otherwise

eligible to be registered as FIIs /sub-accounts under SEBI (FIIs) regulations, 1995 may

be continued to allow.

Ceiling on FII and sub-accounts: The existing limit of 10% holding in any firm by any

one FII may be extended to cover the sum of the holdings of any one FII and all such

sub-accounts coming under that FII which have common beneficial ownership as the FII.

The onus for establishing that a sub-account does not have a common beneficial

ownership will lie with the FII. This requirement may be phased in over a five year

period, with a limit of 20% by December 2005, 18% by 2006, 16% by 2007, 14% by

2008, 12% by 2009 and 10% by 2010.

93


CHAPTER 10 - CONCLUSION

94


One cannot expect the FIIs to take an active interest in the developmental concerns of

the emerging economies. If there is any benefit that accrues to the emerging economies it

will only be incidental.

The main driving force behind the actions of these institutional investors is profit. FIIs

tend to invest selectively in companies that achieve good results or show potential for

future profitability. The share prices of such companies have risen substantially. This

then can have a compounding effect on the size and nature of the firm in that the firm can

now acquire other firms and hence grow even more. What might ensue is also a healthy

competition among firms vying for foreign investment or foreign ownership in terms of

shareholders. In order to attract foreign investment these firms could possibly employ

greater transparency and improve corporate governance.

In terms of the macroeconomic impact of FII investments in India we also need to

consider the effect of the enormous inflows of foreign exchange that occur as a result of

these capital inflows. This inflow of foreign exchange exerts an upward pressure on the

Rupee. The appreciation of the Rupee would mean that imports into India become

cheaper and exports become more expensive. As imports become cheaper and exports

become more expensive, importers stand to gain from cheaper imports and on the whole

those industries that use imported raw materials will face lower costs. This in turn will

lead to lower prices and have a welcome deflationary effect. The appreciation of the

Rupee also simultaneously makes Indian exports less competitive in the global economy,

thus forcing organizations to be more productive and focus on quality.

Foreign institutional investors have played significant roles in other emerging

economies too.

On the flip side though, we find that FII investment in a country would bring in a lot

more volatility than what may have been experienced before in the financial markets. A

large outflow of funds due to FII activities can leave behind a crisis situation in the

domestic economy which threatens to spill over to the rest of the world.

In India too, by opening the economy to short term capital flows, we run the risk of

becoming more vulnerable to any sudden capital outflows from the economy. Even when

there are no such sudden outflows, the large inflows of funds can create problems by

making Indian exports less competitive. 95


However on the whole, it may not be wrong to say that in India, the FIIs have been

instrumental in capital formation in a significant way. Some might even attribute the

buoyancy in the market and steady inflow of dollars into the economy to this upsurge in

FII activity in India. The resultant appreciation of the Rupee has also had its own

implications for the Indian economy.

However on the downside there are some severe implications in terms of increased

volatility in financial markets. This volatility majorly impacts the small local investors in

these markets. Another significant development has been that the Indian markets are now

no longer insulated from the world markets not only through the international flow of

goods and services but also due to this international flow of capital. The jury is still out

on the impact of FII investment in India whether positive or negative.

96


CHAPTER 11 – REFERENCES

Bibliography:

Chopra, Chanchal, 2003, Foreign Investment In India Liberalisation and WTO – The

Emerging Scenario, Deep & Deep Publications Pvt .Ltd.

Chandra, P.C., 2006, Financial Management, Tata McGraw-hill

Pandey, I.M., 2008, Financial Management, Vikas publication

Webliography:

Ezine article, http://ezinearticles.com/?India-Sensex-Volatility---Mutual-Funds-vs-

Foreign-institutional-investors&id=819067

Article base, http://www.articlesbase.com/investing-articles/investment-from-abroad-

is-right-or-wrong 216418.html

Reserve Bank of India, http://www.rbi.org.in/advt/FIINRI.html

Department of Economic Affairs, Press Note dated 14th Sept. 1992 of Department of

Economic Affairs, (Investment Division), Ministry of Finance

Foreign Institutional Investor, http://madaan.com/fii.html#newrule

foreign institutional investments And the Indian stock market by K.s. chalapati rao,

k.v.k. ranganathan and m.r. murthy at http://isidev.nic.in/pdf/FII&ISM.pdf

Article Base, http://www.articlesbase.com/investing-articles/investment-from-abroad-

is-right-or-wrong-216418.html

Financial Express, http://www.financialexpress.com/news/fii-vs-fdi/127133/

http://finance.indiamart.com/india_business_information/

sebi_foreign_institutional_investor.html

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