Foreign
Institutional Investors (FIIs): Increasing Trend In India
Rajesh
Kumar A. Saini
Executive Summary
Foreign
institutional investors have gained a significant role in Indian capital
markets. Availability of foreign capital depends on many firm specific factors
other than economic development of the country. In this context this paper
examines the contribution of foreign institutional investment particularly
among companies included in sensitivity index (Sensex) of Bombay Stock
Exchange. Also examined is the relationship between foreign institutional
investment and firm specific characteristics in terms of ownership structure,
financial performance and stock performance. It is observed that foreign
investors invested more in companies with a higher volume of shares owned by
the general public. The promoters’ holdings and the foreign investments are
inversely related. Foreign investors choose the companies where family
shareholding of promoters is not substantial. Among the financial performance
variables the share returns and earnings per share are significant factors
influencing their investment decision.
Introduction
Entities
covered by the term ‘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 outside India proposing to make proprietary
investments or investments on behalf of a broad-based fund
Foreign
portfolio inflows through FIIs, in India, are important from the policy
perspective, especially when the country has emerged as one of the most
attractive investment destinations in Asia. In this paper an effort has been
made to develop an understanding of the investment decisions, trading
strategies and behavior of the FIIs in the Indian equity market.
With the emerging market crises of
the late 1990s, the role of Foreign Portfolio Investment (FPI) and the major
players therein i.e. the foreign institutional investors (FIIs) has come under
intense scrutiny by academics as well as policymakers. A general perception
about the FIIs is that they are speculators and their investment is motivated
by short- term gains. The FIIs in pursuit of short- term gains adopt short-
term trading strategies such as positive feedback trading and herding (i.e. buy
or sell stocks together as a group). Such behavioral biases of FIIs, it is
believed, may lead to price overreaction and contribute to the creation or
exacerbation of a financial crisis.
What is FII? How it is
permitted?
An investor or investment fund that is
from or registered in a country outside of the one in which it is
currently investing. Institutional investors include hedge funds,
insurance companies, pension funds and mutual funds.
The term is used most commonly in India to
refer to outside companies investing in the financial markets of India.
International institutional investors must register with the Securities and
Exchange Board of India to participate in the market. One of the major market
regulations pertaining to FIIs involves placing limits on FII ownership in
Indian companies.
Foreign Direct Investment in India is
permitted as under the following forms of investments:
FDI is not permitted in the following
industrial sectors:
Foreign direct investments in India are
approved through two routes:
1. Automatic approval by RBI:
The Reserve Bank of India accords automatic approval within a period of two
weeks (provided certain parameters are met) to all proposals involving:
Investments in high-priority
industries or for trading companies primarily engaged in exporting are given
almost automatic approval by the RBI.
FDI in India on automatic route
is not allowed in the following sectors:
2. FIPB Route: Foreign Investment
Promotion Board (FIPB) is a competent body to consider and recommend foreign
direct investment, which do not come under the automatic route. Normal
processing time of an FDI proposal in FIPB is 4 to 6 weeks. FIPB is located in
the Department of Economic Affairs, Ministry of Finance. Its constitution is as
follows:
FIPB can co-opt Secretaries
to the Govt. of India and other top officials of financial institutions, banks
and professional experts of industry and commerce, as and when necessary.
Foreign Investment Implementation Authority (FIIA)
Government has set up
Foreign Investment Implementation Authority (FIIA) to facilitate quick
translation of Foreign Direct Investment (FDI) approvals into implementation by
providing a pro-active one stop after care service to foreign investors, help
them obtain necessary approvals and by sorting their operational problems. FIIA
is assisted by Fast Track Committee (FTC), which have been established in 30
Ministries/Departments of Government of India for monitoring and resolution of
difficulties for sector specific projects.
Factors contributed significantly to the FII flows to
India:
Regulation
and Trading Efficiencies: Indian
stock markets have been well regulated by the stock exchanges, SEBI and RBI leading
to high levels of efficiency in trading, settlements and transparent dealings
enhancing the confidence level of FIIs in increasing allocations to India.
New
Issuance: We have
witnessed extremely high quality issuance during the year from companies such
as NTPC, ONGC and TCS leading to strong FII participation with successful new
issuance of over $ nine billion, yet another record for the year.
Attractive
Markets: Indian
equity markets continue to be attractive to foreign investors with expected earnings
growth of over 13 per cent compared with negative growth expected among
competing countries in the region such as Taiwan and Korea. Indian blue chips
are seen to have high quality of balance sheets with net debt to equity of the
top 30 companies being negative, with net cash on the balance sheets. However
earnings growth is expected to be lower than last year and upside in stock
prices will be subject to sentiments in the global markets and foreign flows to
emerging markets. However high quality new issuance from PSUs and other large
corporates will continue to see good demand from FIIs. However domestic mutual
funds have been net sellers of equities during 2004 with risk aversion still
prevalent among local investors after seeing several short periods of high
volatility. With the booming stock markets presently catching the headlines in
local press, this trend will hopefully reverse during 2005.
Outsourcing:
The rhetoric over
outsourcing of jobs to India has died down after the US elections and demand
will soar for Indian BPO and software services companies. However Indian
software companies will need to enhance margins by going up the value chain to
high level consulting and scaling up the project sizes. Significant outsourcing
opportunities will also open up in textiles and drugs with dismantling of
quotas for textiles and introduction of product patent regime for
pharmaceuticals.
Infrastructure:
Woefully inadequate
infrastructure is the biggest bottleneck for the growth and profitability of Indian
corporations. The administration needs to move much faster in privatisation of
Projects in the areas of power, transportation, ports, airports and other urban
infrastructure to enhance competitiveness. This is particularly relevant due to
the fact that competing countries in Asia Pacific and China have moved at a
much faster pace during the last five years and have in place a first
world infrastructure.
Capex
Cycle: With
strong balance sheets, high liquidity in the banking system, supportive capital
markets and growing demand for goods and services we expect to see a strong
wave of capital expenditure cycle
during the year leading to tremendous opportunities for Indian equities.
Dollar
Weakness: Analysts
continue to look for a weak US dollar with the US twin deficits (budget and
trade deficits) unlikely to be resolved anytime soon. Studies have shown that
flows into emerging markets rise significantly during times of dollar weakness
and India will continue to be a beneficiary of this trend. Indian Rupee is
expected to strengthen further during 2005 which will be particularly
favourable for domestic demand oriented businesses such as banks and
automobiles.
Rising
Commodity Prices: Demand
supply dynamics in both crude and metals call for higher prices during 2005
with increasing Chinese demand and economic recovery in Japan. This has
inflationary implications for India going forward, though it will be a boon for
commodity counters.
Consolidation:
FII activity has been
focused on large cap companies due to liquidity reasons, and hence several high
quality mid cap companies trade at a valuation discount due to lack of investor
demand. We expect to see significant merger activity among mid caps which will
enable them to gain better valuations under the institutional radar screen, in
addition to consolidation efficiencies. While China attracts significantly
higher FDI, India with its highly developed capital markets will be a
beneficiary of FII flows at increasing pace each year. To summarise, Indian markets
have successfully absorbed the gains seen during 2003 and consolidated well
during 2004 with a modest gain and look set to outperform the global financial
markets during 2005.
Trends of FII investment in India:
Past years’ FII investment in
India
|
FII investment in India: |
|
|
|
|
Year |
Gross purchases (Rs crore) |
Gross sales (Rs crore) |
Net Inv (Rs cr) |
|
1993 |
2,661.90 |
66.8 |
2,595.10 |
|
1994 |
9,267.20 |
2,476.10 |
6,791.20 |
|
1995 |
6,665.90 |
2,812.20 |
3,853.80 |
|
1996 |
15,739.20 |
4,935.60 |
10,803.60 |
|
1997 |
18,926.50 |
12,719.20 |
6,207.30 |
|
1998 |
13,899.80 |
15,379.70 |
-1,479.90 |
|
1999 |
37,211.50 |
30,514.70 |
6,696.80 |
|
2000 |
77,666.60 |
71,155.40 |
6,511.20 |
|
2001 |
56,799.20 |
43,506.50 |
13,292.70 |
|
2002
|
5,446.00 |
4,746.70 |
699.30 |
|
Total |
2,44,283.8 |
1,88,313.0 |
55,970.00 |
2009: FII Investment is
increasing in India:
Nearly half of the Rs 70,000 crore offshore investments that have come
into Indian bourses this fiscal, till October 2009, are from alleged tax havens
such as Mauritius, Hong Kong and Luxembourg—the three together contributing
almost Rs 25,000 crore of the net inflow from foreign institutional investors
(FIIs).
Significant omissions from this list are FIIs of
Singapore and Switzerland, the two countries that had figured among the top
five with the highest investments in Indian equities during the economic
slowdown of 2008. FIIs from the two countries had put in over Rs 15,000 crore
last year. The government has said there is no cause of concern on the strong
FII flow into stock markets with finance minister Pranab Mukherjee stating that
regulators were keeping a close watch on the money flow and would act if it was
alarming.
Till October 2009, FII held equities totalled more than $160
billion. According to a finance ministry statement, the highest investments
have come from US-based FIIs, to the tune of Rs 21,344 crore till November 10.
Second on the list is Luxembourg with Rs 12,275 crore. France, Mauritius, the
UK, UAE, Hong Kong, Australia, Norway and Canada are the other countries in the
top 10, in that order.
Investments from Mauritian FIIs have been Rs 9,400 crore, ahead of
the UK (Rs 4,900 crore), UAE (Rs 4,800 crore) and Hong Kong (Rs 3,438 crore).
What can be of concern for the government is the rising share of
participatory notes (PNs) in the total FII flow into stock markets. Since the
identity of PN investors is not known, the government had put a tight leash
last year on such investments after it feared that some dirty money may have
entered the market riding on P-notes. The story was similar in 2006 when
Luxembourg topped all other countries with maximum investment of Rs 12,600
crore. The top four that year included Singapore, Hong Kong and UAE—the US was
a distant fifth with Rs 3,300 crore FII investments

One-third of investments made via PNs:
Poor market conditions towards the end of 2008
had forced the government to remove restrictions on participatory notes (PNs),
but it had asked FIIs to register in India rather than investing through PNs.
It is estimated that of net FII inflows of Rs 44,000 crore during
September-October 2009, nearly a third, or Rs 14,000, crore investment was on
account of PNs.
Findings
and Conclusion:
Domestic
sources of outside finance are limited in many countries, particularly those
with emerging markets. Through capital market liberalization, foreign capital
has become increasingly significant source of finance.
Since
India is a labour intensive country. Therefore, in developing countries like
India foreign capital helps in increasing the productivity of labour and to
build up foreign exchange reserves to meet the current account deficit. Foreign
Investment provides a channel through which country can have access to foreign
capital.
It is
required to understand when they withdraw their funds and when they pump in
more money. Higher Sensex indices and high price earnings ratio are the country
level factors attracting more foreign investment in India.
This
paper empirically observed that the research that market performance is the
strong basis for attracting more foreign investment for the individual
companies in India. The foreign institutional investors with draw their money
when the stock market performance starts sliding down.