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CHAPTER II
FOREIGN INSTITUTIONAL INVESTORS AND INVESTMENT: AN
OVERVIEW
2.1 INTRODUCTION
Indian stock market has grown steadily over the years alluring domestic
investors and foreign investors as a hotspot of investment. The major part of
investment in Indian stock market is attributed to institutional investors among whom
foreign investors are prominent in the post-liberalisation period. This chapter gives a
brief sketch on conceptual and functional framework of FIIs and their benefits. The
discussion on evolution of foreign institutional investment in Indian market and the
development policies initiated by the Indian government regarding foreign
institutional investors have been also described in this chapter.
2.2 EVOLUTION OF FOREIGN INSTITUTIONAL INVESTMENTS
Until the late 1980s, India’s economic development strategy was focused on
self-reliance and import substitution. Current account deficits were financed largely
through debt flows and official development assistance. There was a general
disinclination towards foreign investment or private commercial flows. After the
launch of the liberalisation measures in the early 1990s, there was a gradual shift
towards capital account convertibility. From September 14, 1992, with suitable
restrictions, FIIs and Overseas Corporate Bodies (OCBs) were permitted to invest in
financial instruments. The evolution of FII policy in India has displayed a steady and
cautious approach to liberalisation of a system of quantitative restrictions (QRs). The
policy liberalisation has taken the form of:
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(i) relaxation of investment limits for FIIs;
(ii) relaxation of eligibility conditions;
(iii)Liberalisation of investment instruments accessible for FIIs.
The measures introduced by the government to liberalize provisions relating to
foreign investments in 1991 attracted investors from every corner of the world. Since
1992, FIIs have been allowed to invest in all securities traded on the primary and
secondary markets, including shares, debentures, and warrants issued by companies
that were listed or were to be listed on the stock exchanges in India and in schemes
floated by domestic mutual funds. As a result foreign investment inflows into India
has increased manifold in the form of foreign direct investment (FDI) and foreign
institutional investment (FII).
2.3 FOREIGN INVESTMENTS: THE INDIAN PERSPECTIVE
Foreign investments in the country can take the form of investments in listed
companies (i.e., FII investments), investments in listed/unlisted companies other than
through stock exchanges (i.e., through the foreign direct investment or private
equity/foreign venture capital investment route), investments through American
Depository Receipts/Global Depository Receipts (ADR/GDR), or investments by
non-resident Indians (NRIs) and Persons of Indian Origin (PIOs) in various forms.
Chart 2.1 reveals these forms of foreign investments.
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Chart 2.1: Foreign Investments in India
Source: NSE
2.4 FOREIGN INSTITUTIONAL INVESTOR:
FII is defined as an institution organized outside of India for the purpose of
making investments into the Indian securities market under the regulations prescribed
by SEBI. The term Foreign Institutional Investor is defined by SEBI as “an institution
established or incorporated outside India which proposes to make investment in India
in securities, provided that a domestic asset management company or domestic
portfolio manager who manages funds raised or collected or brought from outside
India for investment in India on behalf of a sub-account, shall be deemed to be a
Foreign Institutional Investor.” ‘FII’ include “Overseas pension funds, mutual funds,
investment trust, asset management company, nominee company, bank, institutional
portfolio manager, university funds, endowments, foundations, charitable trusts,
charitable societies, a trustee or power of attorney holder incorporated or established
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outside India proposing to make proprietary investments or investments on behalf of a
broad-based fund.
2.4.1 Important Terms Related to FIIs:
1. Sub-account:
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, and who is registered as
a sub-account under the SEBI (FII) Regulations, 1995.
2. Designated Bank:
Designated Bank means any bank in India which has been authorized by the
Reserve Bank of India to act as a banker to FII.
3. Domestic Custodian:
Domestic Custodian means any entity registered with SEBI to carry on the activity
of providing custodial services in respect of securities.
4. Broad Based Fund:
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 49%
shares or units of the fund. If the broad-based fund has institutional investor(s), then it
is not necessary for the fund to have 20 investors. Further, if the broad-based fund has
an institutional investor who holds more than 49% of the shares or units in the fund,
then the institutional investor must itself be a broad-based fund.
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5. Caution List
When the total holdings of FIIs under the scheme reach the limit of 2 percent
below the sectoral cap, the RBI issues a notice to all designated branches of the
Authorised Dealer (AD) Category-I banks cautioning that any further purchases of
shares of the particular Indian company will require prior approval of the RBI. The
RBI gives case-by-case approvals to FIIs for the purchase of shares of companies
included in the Caution List. This is done on a first-come, first-served basis.
6. Ban List
Once the shareholding by FIIs reaches the overall ceiling/sectoral
cap/statutory limit, the RBI places the company in the Ban List. Once a company is
placed on the Ban List, no FII or NRI can purchase the shares of the company under
the Portfolio Investment Scheme.
2.4.2 Eligibility for Registration as FII:
According to SEBI regulations, the following conditions have to be adhered to
for registration as FII.
i. An institution established or incorporated outside India as a pension fund, mutual
fund, investment trust, insurance company, or reinsurance company;
ii. An international or multilateral organization or an agency thereof, or a foreign
governmental agency, sovereign wealth fund, or a foreign central bank;
iii. An asset management company, investment manager or advisor, bank, or
institutional portfolio manager that is established or incorporated outside India and
proposes to make investments in India on behalf of broad-based funds and its
proprietary funds, if any;
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should 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 is supposed to report to the RBI and SEBI semi-annually
as part of its disclosure and reporting guidelines.
15. The RBI should 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.
2.4.5 General Obligations and Responsibilities of FIIs:
General Obligations and Responsibilities laid down by the FII Regulations
1995 are as follows:
1) Appointment of domestic custodians: A Foreign Institutional Investor or a global
custodian acting on behalf of the Foreign Institutional Investor, should enter into an
agreement with a domestic custodian to act as custodian of securities for the Foreign
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Institutional Investor. The Foreign Institutional Investor should ensure that the
domestic custodian takes steps for -
monitoring of investments of the Foreign Institutional Investor in India;
reporting to SEBI on a daily basis the transactions entered into by the
Foreign Institutional Investor;
preservation for five years of records relating to his activities as a Foreign
Institutional Investor; and
furnishing such information to SEBI as may be called for by SEBI with
regard to the activities of the Foreign Institutional Investor and as may be
relevant for the purpose of this regulation.
A Foreign Institutional Investor may appoint more than one domestic
custodian with prior approval of SEBI, but only one custodian may be appointed for a
single subaccount of a Foreign Institutional Investor.
2) Appointment of designated bank: A Foreign Institutional Investor should appoint
a branch of a bank approved by the Reserve Bank of India for opening of foreign
currency denominated accounts and special non-resident rupee accounts.
3) Investment advice in publicly accessible media: A foreign institutional investor
or any of his employees should not render directly or indirectly any investment advice
about any security in the publicly accessible media whether real-time or non real-
time, unless a disclosure of his interest including long or short position in the said
security has been made, while rendering such advice. In case of an employee of the
foreign institutional investor is rendering such advice, he should also disclose the
interest of his dependent family members and the employer including their long or
short position in the said security, while rendering such advice.
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4) Maintenance of proper books of accounts, records, etc: Every Foreign
Institutional Investor should keep or maintain, as the case may be, the following
books of accounts, records and documents, namely:
a) true and fair accounts relating to remittance of initial corpus for buying,
selling and realising capital gains of investment made from the corpus;
b) accounts of remittances to India for investments in India and realising capital
gains on investments made from such remittances;
c) bank statement of accounts
d) contract notes relating to purchase and sale of securities; and
e) communication from and to the domestic custodian regarding investments in
securities.
The FII is suppose to intimate SEBI in writing the place where such books,
records and documents will be kept or maintained.
5) Preservation of books of accounts, records, etc: Every Foreign Institutional
Investor should preserve the books of accounts, records and documents mentioned
above.
6) Appointment of compliance officer: Every FII should appoint a compliance
officer who would be responsible for monitoring the compliance of the Act, rules and
regulations, notifications, guidelines, instructions, etc, issued by the SEBI or the
central government. The compliance office officer has to immediately and
independently report to the SEBI any non-compliance observed by him.
7) Information to SEBI: Every Foreign Institutional Investor is required to submit to
SEBI or the Reserve Bank of India, as the case may be, any information, record or
documents in relation to his activities as a Foreign Institutional Investor as SEBI or as
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the Reserve Bank of India may require. Further, the FII should disclose information
concerning the terms of and parties to off-shore derivative instruments such as
Participatory notes, Equity Linked Notes or any other such instruments, by whatever
names they are called, entered into by it or its sub-accounts or affiliates relating to any
securities listed or proposed to be listed in any stock exchange in India as and when
and in such form as SEBI may require.
2.4.6 Code of Conduct for FIIs:
The codes of conduct given by SEBI are:
1. A FII and its key personnel are required to observe high standards of integrity,
fairness and professionalism in all dealings in the Indian Securities market
with intermediaries, regulatory and other Government authorities.
2. A FII should at all times render high standards of service, exercise due
diligence and independent professional judgement.
3. A FII should ensure and maintain confidentiality in respect of trades done on
its own behalf and/or on behalf of its sub-accounts/clients.
4. A FII should ensure the following:
a. clear segregation of its own money/securities and sub-accounts
money/securities.
b. arms length relationship between its business of fund
management/investment and its other business.
5. A FII should maintain an appropriate level of knowledge and competency and
abide by the provisions of the Act, regulations made there under and the
circular and guidelines, which may be applicable and relevant to the activities
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carried on by it. Every FII should also comply with the award of the
Ombudsman and decision of SEBI under SEBI (Ombudsman) Regulations
2003.
6. A FII should not make any untrue statement or suppress any material fact in
any documents, reports or information furnished to SEBI.
7. A FII should ensure that good corporate policies and corporate governance are
observed by it.
8. A FII should ensure that it does not engage in fraudulent and manipulative
transactions in the securities listed in any stock exchange in India.
9. A FII or any of its directors or managers should not either through its/his own
account or through any associate or family members, relatives or friends
indulge in any insider trading.
10. A FII should not be a party to or instrumental for –
a) creation of false market in securities listed or proposed to be listed in
any stock exchange in India;
b) price rigging or manipulation of prices of securities listed or proposed
to be listed in any stock exchange in India;
c) passing of price sensitive information to any person or intermediary in
the securities market.
2.4.7 Prohibitions on Investments:
FIIs are not permitted to invest in equity issued by an Asset Reconstruction
Company. FIIs are also not allowed to invest in any company which is engaged or
proposes to engage in the following activities:
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1) Business of chit fund or
2) Nidhi Company or
3) Agricultural or plantation activities or
4) Real estate business, or construction of farm houses (real estate business
does not include development of townships, construction of
residential/commercial premises, roads or bridges).
5) Trading in Transferable Development Rights (TDRs)
2.4.8 FII POLICY - TIMELINE OF DEVELOPMENTS
The historical evolution of the FII policy is summarized in the Table2.4.1. The
objective of these policy changes was to increase the participation by FIIs, to allow
operational flexibility, and also to give access to domestic asset management
capability.
Table 2.4.1: Timeline of FII Policy Developments
Year Policy changes
1992 FIIs are allowed to invest by the government guidelines in all securities in
primary and secondary markets as well as in schemes floated by mutual
funds. Single FIIs to invest 5 percent and all FIIs are allowed to invest 24
percent of a company’s issued capital. Broad-based funds shall have 50
investors with no one holding more than 5 percent.
1997
The aggregated limit for all FIIs increased to 30 percent, subject to
special procedure and resolution.
1998 FIIs permitted to invest in dated government securities subject to a ceiling
of US $ 1 billion. The aggregate portfolio investment limit of FIIs was
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enhanced from 5 percent to 10 percent, and the ceilings made mutually
exclusive.
2000 Foreign firms and high net worth individuals permitted to invest as sub-
accounts of FIIs. Domestic portfolio manager were allowed to be
registered as FIIs to manage the funds of subaccounts.
2001 FII ceiling under special procedure was enhanced to 49 percent to
increase FII participation. FII ceiling under special procedure was also
raised in sectoral cap.
2003 The FII dual approval process of the SEBI and the RBI changed to a
single approval process of the SEBI to streamline the registration process.
2006 FII investment up to 23% permitted in market infrastructure institutions
in the securities markets, such as stock exchanges, depositories, and
clearing corporations.
2007 FIIs were allowed to invest US $ 3.2 billion in government securities.
2008 Government increased the cumulative debt investment limits from US $ 3
billion to US $ 6 billion for FII investments in corporate debt. The
restriction of investment at a ratio of 70:30 in equity and debt was
removed. The restrictions on Overseas Derivatives Instruments (ODIs)
were removed.
2009
FIIs lending shares abroad was disapproved and E-bids platform for FIIs
were introduced. FIIs are allowed to participate in interest rate futures.
2010 FIIs are allowed to offer domestic government securities and foreign
sovereign securities with AAA rating as collateral (in addition to cash) to
recognized stock exchanges in India for their transactions in the cash
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segment of the market. The Investment caps for FIIs were increased by
US $ 5 billion each in government securities and corporate bonds to US $
10 billion.
2011 The limit of US $ 5 billion in corporate bonds issued by companies in the
infrastructure sector with a residual maturity of over five years increased
by an additional limit of US $ 20 billion, taking the total limit to US $ 25
billion.
2.4.9 Mauritius Route of Foreign Investment
Double Taxation Avoidance Agreement (DTAA) with Mauritius was signed
by India in August 1982. The treaty specified that capital gains made on the sale of
shares of Indian companies by investors resident in Mauritius would be taxed only in
Mauritius and not in India. In 1992, Mauritius passed the Offshore Business Activities
Act which allowed foreign companies to register in the island nation for investing
abroad. As a result, the benefits are quick incorporation of a company in Mauritius,
total exemption from capital- gains tax, total business secrecy and a completely
convertible currency. The DTAA has helped Mauritius in the development of its
Financial Services sector; India has on the other hand benefitted in terms of foreign
investments. Many Indian and foreign-based companies have set up subsidiaries in
Mauritius only to avail themselves of tax exemptions. Some of its salient features are:
Capital gains earned by the Fund (organized in Mauritius) registered as a sub-
account of an FII from its investments in Indian Companies would be tax
exempt subject to the condition that it does not have a permanent
establishment in India.
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Interest income earned by the Fund (organized in Mauritius) registered as a
subaccount of an FII from India from debt (whether listed or unlisted) incurred
in foreign currency would be taxed at the rate of 20%.
Interest income earned by the Fund (organized in Mauritius) registered as a
subaccount of an FII from all investments in listed debt securities of Indian
Companies (whether or not incurred in foreign currency) would be taxed at the
rate of 20%.
Interest income earned by the Fund (organized in Mauritius) registered as a
subaccount of an FII other than that mentioned above would be taxed at the
rate of 35% under the India-Mauritius tax treaty.
Dividends earned by the Fund would not be subject to any withholding tax in
India.
2.4.10 Tax Provisions for FIIs
According to Income-tax Act, 1961; tax provisions for FIIs are summarised as
follows:
a. Interest earned by an entity (registered as an FII or sub-account of a registered
FII) from India from its investments in listed debt securities of Indian
Companies (whether or not incurred in foreign currency) will be taxed at the
rate of 20% under section 115AD of the Income-tax Act, 1961 (the “ITA”).
b. Interest income of an entity (registered as an FII or sub-account of a registered
FII) from debt (whether listed or unlisted) incurred in foreign currency would
be taxed at the rate of 20% under section 115A of the ITA.
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c. Other interest income earned by an entity (registered as an FII or sub-account
of a registered FII) from unlisted debt not incurred in foreign currency would
be taxed at the rate of 48%.
d. Long-term capital gains earned by an entity (registered as an FII or sub-
account of a registered FII) from sale of listed debt securities of Indian
Companies would be taxed at the rate of 10% and short-term capital gains
would be taxed at 30% in terms of section 115AD of the ITA.
e. Long-term capital gains earned by an entity (registered as an FII or sub-
account of a registered FII) from sale of unlisted securities of Indian
Companies would be taxed at the rate of 20% and short-term capital gains
would be taxed at 48% under the ITA.
f. Dividends earned by an entity (registered as an FII or sub-account of a
registered FII) would not be subject to any withholding tax in India.
2.5 TRENDS IN FOREIGN INVESTMENT IN INDIA
The measures introduced by the government to liberalize provisions relating to
foreign investments in 1991 lured investors from every corner of the world. As a
result foreign investment inflows to India has increased manifold as the foreign direct
investment (FDI) and foreign institutional investment (FII). The data in the given
Table2.5.1 provides the trend foreign investment flows into India classified as Foreign
Direct Investment (FDI) and Portfolio Investments (FII). Foreign direct
investment (FDI) refers to the net inflows of investment to acquire a lasting
management interest (10 percent or more of voting stock) in an enterprise operating in
an economy other than that of the investor. Foreign Institutional Investment (FII)
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refers to outside companies investing in the financial markets of India. International
institutional investors must register with the Securities and Exchange Board of India
to participate in the Indian markets.
Table: 2.5.1Trend of Foreign Investments in India
Year A. Direct
investment B. Portfolio investment Total Investment (A+B)
Rs. Crore Rs. Crore Rs. Crore 1990-91 174 11 185
1991-92 316 10 326
1992-93 965 748 1,713
1993-94 1,838 11,188 13,026
1994-95 4,126 12,007 16,133
1995-96 7,172 9,192 16,364
1996-97 10,015 11,758 21,773
1997-98 13,220 6,794 20,014
1998-99 10,358 -257 10,101
1999-00 9,338 13,112 22,450
2000-01 18,406 12,609 31,015
2001-02 29,235 9,639 38,874
2002-03 24,367 4,738 29,105
2003-04 19,860 52,279 72,139
2004-05 27,188 41,854 69,042
2005-06 39,674 55,307 94,981
2006-07 103,367 31,713 135,080
2007-08 140,180 109,741 249,921
2008-09 173,741 -63,618 110,123
2009-10 179,059 153,516 332,575
2010-11 138,462 143,435 281,897
Source: SEBI
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The distinction between FDI and FII is that FDI have lasting interest in
management of the firm while FII are “fair weather friends” who are concerned about
safety of their investment. The Table 2.5.1 reveals the investments made in FDI and
FII ever since 1990-91 in India. It can be noticed that FDI has shown a steady growth
of Rs.174 crores in 1990-91 to Rs. 179,059 crores 2009-2010. There has been sharp
increase of FDI in the year 2006-07 from Rs. 103,367 crores from the previous year
of Rs. 39,674crores. In contrast portfolio investments indicate periods of up trends
and down trends since 1990-91. There have been more capital outflows than inflows
during the years 1998-99 and 2008-2009 as far as portfolio investments are
concerned.
2.5.1 Registered FIIs in India:
The Table2.5.2 highlights the number of FIIs registered in India since
initiation of foreign investments in India. With liberalisation of Indian economy, there
has been a steady increase in registration of FIIs in India from 1993. The number of
registered FIIs in 1995 was 156 which has rose to 1765 in 2011. Some prominent FIIs
registered in India are: California Public Employees’ Retirement System (CalPERS),
United Nations for and on behalf of the United Nations Joint Staff Pension Fund,
Public School Retirement System of Missouri, Commonwealth of Massachusetts
Pension Reserves Investment Trust, Treasurer of the State North Carolina Equity
Investment Fund Pooled Trust, the Growth Fund of America, and AIM Funds
Management Inc (Department of Economic Affairs, Ministry of Finance).
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Table: 2.5.2 Number of Registered FIIs
Financial Year Number of FIIs registered with SEBI
1993 0
1994 3
1995 156
1996 353
1997 439
1998 496
1999 450
2000 506
2001 527
2002 490
2003 502
2004 540
2005 685
2006 882
2007 997
2008 1319
2009 1635
2010 1722
2011 1765
Source: NSE
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Registered FIIs in India have various countries of origin. 42% of FIIs are from
US, followed by UK (20%) and Europe (17%) as indicated in Chart2.5.1. The
diversity of FIIs has been increasing with the number of registered FIIs in India
steadily rising over the years.
Chart: 2.5.1 Sources of FIIs in India
Source: SEBI
The Chart2.5.2 shows a constant growth of registered FIIs in India irrespective
of the stock market performance in India. It also shows that net investment made by
FIIs have not proportionately increased as the number of registered FIIs.
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Chart: 2.5.2 Number of FIIs and Net Foreign Institutional Investment
Source: NSE
2.5.2 Sensex movements and FII
According to information given by SEBI, the net investment made by FIIs was
highest in the year 2010-2011. A negative trend was noticed in the year 1999 and
2009 due to East-Asian crisis and Global financial crisis respectively. According to
financial press, FIIs are facing a cash crunch in their home markets and shrinking
profit margins of Indian investments attributes to decline in amount of net investments
made by FIIs.
Chart: 2.5.3 FII and Sensex Behaviour
Source: SEBI
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Since the beginning of liberalisation, FII flows to India have steadily grown in
volume and importance. Over the same time, Sensex, the benchmark index measuring
the stock market performance, has also shown remarkable growth. India, with the
world’s second highest growth rate, has been an attractive market for foreign
investors. Since 2001, FIIs have invested huge money into the Indian equity market
which is one of the major reasons for the significant jump in Sensex over the last
decade. Despite the economic slowdown, FIIs have continued to pump in money in
India. DIIs too have been investing in the Indian stock market; however, the level of
investments and their investment strategy differs from FIIs, as shown in chart 2.5.4.
Chart: 2.5.4 Institutional Investments and Sensex
Source: BSE
2.5.3 Composition of Foreign Institutional Investment in India
Foreign Institutional Investments in Indian stock market may take the form of
equity or debt. The amount invested by FIIs is more in equity compared to debt
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investments and hence total investments of FIIs are depends heavily upon equity
investments. Table 2.5.3 depicts that FIIs have been investing in equity instruments
since 1993 but started investing in the debt instruments only from 1997.
Table: 2.5.3 Investments by FIIs in Equity and Debt
Financial Year Net investment by FIIs(Rs crore)
Equity Debt Total
1993 13 0 13
1994 5,127 0 5,127
1995 4,796 0 4,796
1996 6,942 0 6,942
1997 8,546 29 8,575
1998 5,267 691 5,958
1999 -717 -867 -1,584
2000 9,670 453 10,122
2001 10,207 -273 9,933
2002 8,072 690 8,763
2003 2,527 162 2,689
2004 39,960 5,805 45,765
2005 44,123 1,759 45,881
2006 48,801 -7,334 41,467
2007 25,236 5,605 30,840
2008 53,404 12,775 66,179
2009 -47,706 1,895 -45,811
2010 1,10,221 32,438 1,42,658
2011 1,10,121 36,317 1,46,438
2012 43,738 49,988 93,726
2013 1,40,033 28,334 1,68,367
Total 6,28,377 1,68,467 7,96,844
Source: SEBI
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In terms of net cumulative investments by FIIs, US-based FIIs dominate with
45 percent of the net cumulative FII investments in India, followed by UK at 18 per
cent. Chart2.5.5. Also a significant number belonged to Europe and Japan FIIs that
registered with SEBI in recent years. These developments have helped improving the
diversity of the set of FIIs operating in India (Department of Economic Affairs,
Ministry of Finance).
Chart: 2.5.5 Country Wise Share of Net FII in India
Source: SEBI
Table 2.5.4 indicates FII turnover in the Indian stock markets from the year
2001 to the year 2012. Purchases by FIIs have been more than the sales through the
study period except in the 2009.
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Table: 2.5.4 Trends in FII turnover
Year Gross Purchases (INR crore)
Gross sales (INR crore)
Net Investment (INR crore)
2001 74051 64118 9933
2002 50071 41308 8763
2003 47062 44372 2689
2004 144855 99091 45764
2005 216951 171071 45880
2006 346976 305509 41467
2007 520506 489665 30841
2008 948018 881839 66179
2009 614576 660386 -45811
2010 846433 703776 142658
2011 992596 846158 146438
2012 921285 827562 93725
Source: SEBI
2.5.4 FII Ownership in NSE-Listed Companies
The FII ownership of shares in the various sectors of NSE-listed companies is
depicted in Table 2.5.5. FIIs held the highest stake of 18.41 % in the Banking sector
followed by Finance and Media & Entertainment of 18.18 % and 15.20 %
respectively. At the end of March 2013, FIIs held the highest stake of 16.9 percent in
the banking sector, followed by FMCG and finance (9.2 percent and 8.8 percent,
respectively). The total percentage of shares held by FIIs across different sectors was
6 percent of the total shares of the companies listed on the NSE as at the end of March
2013 which has decreased from 10.78 percent at the end of March 2007.
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Table 2.5.5 : Sectoral Composition of FII in NSE
Sectors
Percentage Share of Foreign institutional Investors at the end of
Mar-07 Mar-08 Mar-09 Mar-10
Mar-11
Mar-12
Mar-13
Banks 18.41 19.15 14.27 16.02 17.62 15.9 16.9
Engineering 11.45 10.63 7.34 8.28 9.36 5.1 4.6
Finance 18.18 17.44 13.01 16.53 23.35 8.4 8.8
FMCG 11.91 14.07 12.72 14.09 16.34 9.4 9.2
Information Technology 14.53 16 12.44 11.68 21.16 7.3 7.2
Infrastructure 7.15 8.86 7.31 8.9 7.87 5.9 6.3
Manufacturing 9.57 9.46 7.28 8.79 9.41 4.8 4.6
Media & Entertainment 15.2 11.7 11.42 7.06 10.97 5.8 6.1
Petrochemicals 5.85 14.73 4.77 6.08 6.52 4.5 5.1
Pharmaceuticals 11.17 10.69 7.88 8.78 10.19 6.2 6.8
Services 13.09 10.7 8.39 8.05 7.41 5.4 5.2
Telecommunication 11.17 9.12 6.85 8.64 8.44 5.7 5.6
Miscellaneous 8.9 9.3 8.39 8.1 13.65 6.1 5.8
Total stake of FIIs in all the Sectors 10.78 10.62 8.4 9.58 10.32 6 6
Source : NSE
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2.6 DEVELOPED VS EMERGING MARKETS – INVESTMENT
PERSPECTIVE
The term “emerging economies” was coined in the early 1980s. Its members
were typically the fast growing economies with low to medium per-capita income
levels that have sustained tremendous economic development in long term,
implemented significant structural reforms, and have “emerged‟ as significant players
in the global economy. Another term known as “Emerging Markets” emerged to
signify a potential market for the future. According to Sharpe (2005), in general, these
countries have in common a relatively low (compared with Western countries) level
of per capita gross domestic product (GDP), improving political and economic
stability, a currency convertible into Western countries’ currencies and most
important, securities available for investment by foreigners. Investing in emerging
stock markets have proven attractive to a number of foreign individual and
institutional investors who in many cases have invested directly in those securities or
when that is not possible, through countries funds. Because their stock markets are not
highly developed and therefore are less efficient, there are considerable opportunities
for relatively high returns from emerging market investment. Also there is a relatively
high level of risk involved as witnessed by the meltdown of several Asian emerging
stock markets in 1997, 1998, 2007 and 2008 according to Sharpe (2005). Domestic
debt levels in these markets are low coupled with higher savings rate as shown in
Chart2.6.1 provides a platform for credit growth which in turn will boast domestic
spending thus driving demand leading to economic expansion in emerging economies.
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Chart 2.6.1: Saving Rate Projections for DM and EM
Source: World Bank
2.6.1 Comparison of Emerging vs. Developed Markets Risk
Typically risks associated with emerging equity markets are higher than that
of developed markets. Also, Betas of EMs are higher than developed markets which
means that EMs are more volatile. The Chart2.6.2 indicates the 3-year rolling
volatility of emerging market and developed market equities. Emerging equity
volatility has been consistently higher.
Chart 2.6.2: Comparing 3-year rolling volatility between DM and EM
Source: MSCI Barra
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2.6.2 Return on Equity (RoE)
Emerging markets offer better RoE as compared to developed markets as
shown in Chart2.6.3.In future also emerging markets are poised at an advantage due
to structural reforms in various sectors, increase in FDI limit, ease of labour and
capital, better transport infrastructure.
Chart 2.6.3: Comparing RoE between DM and EM
Source: MSCI
2.6.3 Price to earnings ratio (P/E)
Since early 2000s, Emerging markets are trading at a discount relative to
developed markets and their own long term average which means that they are
relative cheap as compared to investing in developed markets. The roles of the
emerging economies have now become a key consideration for all investors it
contributes to more than 50% of the global corporate growth as depicted in Chart
2.6.4. Over a long period of time both the markets will converge.
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Chart 2.6.4: Comparing Price to earnings ratio between DM and EM
Source: MSCI
2.6.4 Market capitalization to GDP ratio
Economic development is reflected in the proportion of the economy that is
reflected in the stock market. This dimension is reflected by the ratio of country
market capitalization to GDP. As shown in Chart2.6.5, advanced financial markets
tend to have market capitalization/GDP ratios that are closer to 100%. In contrast,
stock markets in China, India, and Russia capture only a small portion of the
economy. Emerging market companies make of up 26% of global equity market cap
while emerging markets represent 36% of global GDP indicating a lot of gap still
exists between GDP and equity market capitalization.
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Chart 2.6.5: Comparing Market capitalization to GDP ratio of select countries
Source: IMF and MSCI
2.6.5 Sharpe Ratio
Though Emerging markets have been an excellent long-term buy and hold
investment, they have not always compensated for their higher risk. The Sharpe ratio
of the investment is fairly volatile and prone to extreme swings as shown in
Chart2.6.6. Since 2002, the risk-adjusted return of investing in emerging markets has
been consistently higher.
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Chart 2.6.6: Comparing Sharpe Ratio between DM and EM
Source: MSCI
The statistics compared between developed markets and emerging markets are
in support of the fact that the emerging markets are going to reshape a new world
order in the future. The emergence of the emerging markets as the favoured place for
investor’s post the global and the EU crises offering better equity risk premium has
been established however there are still many issues which cast shadow on the
sustainability of these markets as a dream destination. The central bank’s and the
policymakers in the emerging markets face real challenge in protecting their
economies from reversal of capital flows, the FIIs which are very high due to the high
interest rate differentials. High proportion of capital inflows in equity markets expose
these markets to global shocks in the world market and could magnify domestic
policy conundrums.
2.6.6 Investments in BRIC Countries
The Private Equity (PE) investments gained momentum in the late nineties
with the growth of Indian IT companies and with the simultaneous global dot-com
boom. Following the global IT boom, the Indian IT sector was viewed as a prominent
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54
funding opportunity, and consequently, saw a lot of venture capital coming into the
country.
The Table2.6.1 indicates the PE investments of BRIC countries from 2001 to
2011. India and China were found to attract maximum investments. According to a
report by Emerging Markets Private Equity Association (EMPEA) there has been a
decline in the investment to BRIC countries in 2009. Among BRIC countries there is
strong competition between China and India for foreign equity investments. It can be
noticed from the Table2.6 that amount of investments in China and India is very high
compared to Brazil and Russia. All BRIC countries faced a downtrend in investments
during the year 2009.
Table: 2.6.1: Private Equity Investments in BRIC Countries
Year Brazil in US $ mn Russia in US $ mn India in US $ mn China in US $ mn
2001 281 77 320 1575
2002 261 127 40 126
2003 321 113 456 1667
2004 120 240 1272 1389
2005 474 240 1377 2991
2006 1342 402 5687 8200
2007 5285 805 9905 9458
2008 3020 2647 7483 8994
2009 989 217 4011 6288
2010 4604 1516 6222 9190
2011 2461 1579 6172 10529
Source: NSE
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2.6.7 Geographical breakdown of FPIs in India
According to IMF statistics, equity investments form a major chunk of the
Foreign Portfolio Investments in India. Table 2.6.2 indicates USA and Mauritius are
found to be the largest investors in the Indian markets. Many European and Asian
countries have also found to be significant in FPI in India.
Table 2.6.2: Foreign Portfolio Investments in India as on December 2012
Source: IMF
USA is the largest investor in India upto the year 2012 with 75,686 US$
million in equity followed by Mauritius with 72, 831 US$ million. Total investments
made by all countries in India was 3, 13,253 US$ million with 2, 49,737 US$ million
in equity instruments.
Country Equity investments (US$ million) FPI (US$ million)
Australia 2,901 3,115 Canada 4,560 4,657 Denmark 1,542 1,579 France 4,266 4,650 Ireland 3,673 4,084 Japan 3,813 5,195 Korea 1,902 2,025 Luxembourg 28,694 31,180 Mauritius 72,831 78,228 Netherland 5,424 5,841 Norway 2,935 4,260 Singapore 17,875 47,822 Spain 2,743 2,755 Switzerland 1,066 1,944 UK 13,834 22,024 USA 75,686 78,846 Others 5,992 15,050
Total 2,49,737 3,13,253
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2.7 SELECTED VARIABLES FOR THE STUDY
This study includes data on FIIs as dependent variable and select stock indices
and selected macroeconomic variables as independent variables for the study. Data on
purchases, sales and net investments made by FII is considered as explained variable.
Monthly data on select stock indices and selected macroeconomic variables is taken
as explanatory variables for the study.
2.7.1 Selected Stock Indices
NSE and BSE indices are broad-market indices, consisting of the large, liquid
stocks listed on the Exchange are mainly in the study. They serve as a benchmark for
measuring the performance of the stocks or portfolios.
S&P CNX Nifty
The CNX Nifty is a well diversified 50 stock index accounting for 22 sectors
of the economy. It is used for a variety of purposes such as benchmarking fund
portfolios, index based derivatives and index funds. The CNX Nifty Index represents
about 70.14% of the free float market capitalization of the stocks listed on NSE as
on March 31, 2014.
S&P CNX 100
CNX 100 is a diversified 100 stock index accounting for 38 sectors of the
economy. The CNX 100 Index represents about 81.57% of the free float market
capitalization of the stocks listed on NSE as on March 31, 2014. The total traded
value for the last six months ending March 2014 of all index constituents is
approximately 72.53% of the traded value of all stocks on the NSE.
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S&P CNX 500
The CNX 500 is India’s first broad based benchmark of the Indian capital
market. The CNX 500 Index represents about 97.00% of the free float market
capitalization of the stocks listed on NSE as on March 31, 2014. The total traded
value for the last six months ending March 2014, of all Index constituents is
approximately 97.08% of the traded value of all stocks on NSE. The CNX 500
companies are disaggregated into72 industry indices viz. CNX Industry Indices.
Industry weightages in the index reflect the industry weightages in the market. For
e.g. if the banking sector has a 5% weightage in the universe of stocks traded on NSE,
banking stocks in the index would also have an approx. representation of 5% in the
index.
BSE SENSEX
S&P BSE SENSEX, first compiled in 1986, was calculated on a "Market
Capitalization-Weighted" methodology of 30 component stocks representing large,
well-established and financially sound companies across key sectors. It is considered
as- The Barometer of Indian Capital Markets. The base year of S&P BSE
SENSEX was taken as 1978-79. S&P BSE SENSEX today is widely reported in both
domestic and international markets through print as well as electronic media. It is
scientifically designed and is based on globally accepted construction and review
methodology. Since September 1, 2003, S&P BSE SENSEX is being calculated on a
free-float market capitalization methodology. The "free-float market capitalization-
weighted" methodology is a widely followed index construction methodology on
which majority of global equity indices are based; all major index providers like
MSCI, FTSE, STOXX, and Dow Jones use the free-float methodology.
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BSE 100 Index
S&P BSE 100 Index is a broad based Index. This Index has 1983-84 as the
base year and was launched in 1989. In line with the shift of the S&P BSE Indices to
the globally accepted Free-Float methodology, S&P BSE 100 was shifted to Free-
Float methodology effective from April 5, 2004. The method of computation of Free-
Float index and determination of free-float factors is similar to the methodology for
S&P BSE SENSEX
BSE 500 Index
S&P BSE-500, consisting of 500 scrips is calculated from August 9, 1999.
The changing pattern of the economy and that of the market were kept in mind while
constructing this index. S&P BSE 500 index represents nearly 93% of the total market
capitalization on BSE. S&P BSE 500 covers all 20 major industries of the economy.
In line with other S&P BSE indices, effective August 16, 2005 calculation
methodology was shifted to the free-float methodology.
Sectoral Indices
Sector-based index are designed to provide a single value for the aggregate
performance of a number of companies representing a group of related industries or
within a sector of the economy. Select NSE and BSE sectoral indices are used in the
study
2.7.2 Selected Macroeconomic Variables
Call Money Rate (CMR)
Call money refers to short term finance repayable on demand, with maturity
period of one day to fifteen days, used for inter bank transactions. Commercial banks
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have to maintain a minimum cash balance known as cash reserve ratio. The Reserve
Bank of India changes the cash ratio from time to time which in turn affects the
amount of funds available to be given as loans by commercial banks. Call money is a
method by which banks lend from each other to be able to maintain the cash reserve
ratio. The interest rate paid on call money is known as call rate. Portfolio flows to
developing countries are extremely sensitive to interest differentials. Money tends to
flow to countries with high interest rates because of the differences between the
current interest rates in international markets. If the interest rate is high, FII invest to
get capital gains high growth rate.
Exchange Rate(ER)
The next macroeconomic variable used in this study has been the exchange
rate or forex rate. It is regarded as the value of one country’s currency in terms of
another currency.US Dollar ($) has been taken to be the foreign currency against
which the Indian Rupee exchange rate is considered. Sudden and unexpected changes
in exchange rates affect international investors’ returns in their own currencies. If the
risk of such changes in the exchange rate is high, foreign investors would expect a
similarly high rate of return to reward them for the additional risk emanating from
changes in the exchange rate. This, in turn, reduces the number of investment
opportunities offering high enough rates of return. For this reason, sharply fluctuating
exchange rates, or sudden revaluations or devaluations in fixed exchange rates, pose
an obstacle to foreign investment.
Foreign-Exchange Reserves (FER)
Foreign-exchange reserves or forex reserves are assets held by central banks
and monetary authorities, usually in different reserve currencies, used to back its
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liabilities. Holding the currencies of other countries as assets allow governments to
keep their currencies stable and reduce the effect of economic shocks. When there is a
deficit BOP condition, FIIs avoid investing in those countries.
Index of Industrial Production (IIP)
Industrial Production Index is used as proxy to measure the growth rate in real
sector. Industrial production presents a measure of overall economic activity in the
economy and it is a key economic indicator that measures real output from the
manufacturing, mining, and utilities industries. An increase in industrial production
index is positively related to stock price and Portfolio investments are expected to
decline in low return period of stock markets. However, portfolio investments are
expected to increase in high return period of stock markets.
Wholesale Price Index (WPI)
Wholesale Price Index represents the price of goods at a wholesale stage i.e.
goods that are sold in bulk and traded between organizations instead of consumers.
WPI is used as a measure of inflation in India. Adequate money supply and stable
inflation rate attract FII
MSCI Emerging Market Index (MSCI_EM)
Morgan Stanley Capital International Index (MSCI) is used as to proxy the
effects of the state of the global equity markets. MSCI indexes are widely used as the
benchmark indexes by which the performances of global equity portfolios are
measured. The MSCI Emerging Markets Index is a free float-adjusted market
capitalization index that is designed to measure equity market performance in the
global emerging markets launched in 1988. Since then, emerging markets have
become an important and integrated part of a global equity portfolio allocation. The
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MSCI Emerging Markets Index covers over 800 securities across 23 markets and
represents approximately 13% of world market cap.
REFERENCES
Sharpe, William F., Gordon J. Alexander and Jeffery V. Bailey (2003), Investments,
6 ed., Prentice Hall of India Private Limited, New Delhi.
Bhole, L.M.(2004), Financial Institution and Markets: Structure, Growth and
Innovations, Tata McGraw Hill Publishing Company Limited, New Delhi.
Khan, M.Y. (2004), ‘Indian Financial System’, Tata McGraw Hill Publishing
Company Limited, New Delhi, 2004.
Salomons, Roelof and Grootveld, Henk, The Equity Risk Premium: Emerging versus
Developed Markets (August 7, 2002).
NSE: Indian Securities Market: A Review, Volume IV, 2001, National Stock
Exchange, Mumbai.
RBI: Handbook of Statistics on Indian Economy, Reserve Bank of India, Mumbai,
various issues.
SEBI: Annual Report, Various Issues, Securities and Exchange Board of India,
Mumbai.
SEBI: SEBI BULLETIN, Various Issues, Securities and Exchange Board of India,
Mumbai.
http://www.world-exchanges.org/statistics/monthly-reports
http://www.msci.com/products/indices/size/standard/index_review.html
http://www.world- exchanges.org/files/statistics
www.imf.org
www.msci.org
www.sebi.in
www.nse.com
http://epfr.com/
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