Impact of FIIs on Investment Portfolio Essay Sample

Impact of FIIs on Investment Portfolio Pages
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This paper aims to shed light on the behaviour of individual investors when foreign investments inject in the economy. The focus is to study the role of foreign institutional investors in changing the investment decisions of the individual investors and their contribution to economic growth through Capital accumulation in the economy , scope of the study is limited to India. Individual investor we mean by the small investor who invests in capital market, money market, real estate ,gold, bonds, Banks, post office instruments .Individual investment decisions are affected by many factors such as risk tolerance ,type of investor , knowledge of the product ,geographical, demographic factors, economic conditions and most importantly returns of the investment. Individual investors are highly motivated by the higher returns with optimum level of risk .FIIs play active and major role in the volatility of the stock market . Trading by FIIs happens on a continuous basis and therefore has a lasting impact on the local stock market. A significant improvement has also taken place in India relating to the flow of foreign capital during the period of post economic reforms.

The major change in the capital flows particularly in Foreign Institutional Investors (FIIs) investments has taken place following the changes in trade and industrial policy. Over the past 15 years or so India has gradually emerged an important destination of global investors’ investments in emerging equity markets. Foreign portfolio investment is a non–debt creating instrument ,stock market is the important channel to attract foreign capital which increases foreign exchange reserves and fulfil the gap of balance of payments. It has direct impact on economy of developing nations as most of the inflows comes out of the developed nation. FIIs are short term in nature ,much volatile than FDI. When they take out their money ,Indian investors of stock market are highly affected. In this paper emphasis has been placed on the indirect effect of foreign institutional investor in changing the pattern of individual investor’s portfolio.

How an investor alter the composition of portfolio .For instance if stock market returns increases due to heavy foreign capital inflows. Investor instantly reacts to the situation and withdraw his bank fixed deposits to invest in stock market to get good return which in turn strengthen the financial market. Withdrawal from risk free asset and investment in risky asset depends upon the the type of investor i.e risk averse, risk lover. Foreign investment results in appreciation of currency, depreciation of currency, inflationary pressures. These are the common factors which influence the decision of an investor towards various financial instruments.

Literature Review
The waves of liberalization results in appreciation of stock price which is followed by inflows From foreign investors [Bekaert and Harvey (1998a, b), Henry 1997)]. The stock market shows more reaction to foreign investment as the economy liberalizes. A concern with the entry of FIIs is that they are positive feedback traders—traders who buy when the market increases and sell when the market falls. This acts as destabilizing because the sales by FIIs lead the stock market to fall further and their increase the stock market [Dornbusch and Park (1995), Radelet and Sachs (1998), Richards(2002)]. Not only this, these trades push the stock-prices away from the fundamentals as revealed by studies on contemporaneous relation between FIIs investments and equity returns based on monthly data [Bohn and Tesar (1996), Clark and Berko (1996)]. Choe et. al., (1998) examined the influence of FIIs on equity returns in Korea before and during the 1997 Asian crisis and they found no evidence of stock prices falling because of a withdrawal of foreign equity investment. Also, it is not necessary that inviting FIIs to the stock market would increase its volatility [Stultz (1997), Bekaert and Harvey(1998b)].

Most of the existing literature on FIIs in India found that the equity return has a significant and positive impact on the FIIs (Agarwal, 1997; Chakrabarti, 2001; and Trivedi and Nair, 2003). But, given the huge volume of investments, foreign investors could play a role of market makers and book their profits, i.e. they can buy financial assets when the prices are declining, thereby jacking-up the asset prices and sell when the asset prices are increasing (Gordon and Gupta, 2003).

The possibility of bi-directional relationship between FII and the equity returns was explored by Rai and Bhanumurthy (2003). They studied the determinants of foreign institutional investment in India during the period 1994-2002. They found, using monthly data that the equity returns is the main driving force for FII investment and is significant at all levels. They further studied the impact of news on FII flows and found that the FIIs react more (sell heavily) to bad news than to good news.

Sikdar Soumyen (2006) held that the surge in inflows has not been matched by a corresponding growth in the absorptive capacity of the Indian economy. The major reason is the persistent slowdown of industrial activity since 1997. At the same time, the Reserve Bank of India (RBI) has been reluctant to let the rupee find its market-clearing level under the circumstances. This has resulted in steady accretion to our foreign exchange reserves (FER) over the last few years. Problems of Foreign Capital are widening of current account deficit, monetization, appreciation of real exchange

Dhamija Nidhi (2007) held that the increase in the volume of foreign institutional investment (FII) inflows in recent years has led to concerns regarding the volatility of these flows, threat of capital flight, its impact on the stock markets and influence of changes in regulatory regimes. The determinants and destinations of these flows and how are they influencing economic development in the country have also been debated. This paper examines the role of various factors relating to individual firm-level characteristics and macroeconomic-level conditions influencing FII investment. The regulatory environment of the host country has an important impact on FII inflows. As the pace of foreign investment began to accelerate, regulatory policies have changed to keep up with changed domestic scenarios. The paper also provides a review of these changes.

P. Krishna Prasanna (2008) has examined 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.

Foreign Institutional investors
An investor or investment fund that is from or registered in a country outside of the one in which it is currently investing is known as Foreign Institutional Investment and investors are known as Foreign Institutional Investors. 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.

Attracting foreign capital appears to be the main reason for opening up of the stock markets to 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 materializes. Regarding the entry of FIIs the then Finance Minister said at a meeting organized 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. The Finance Minister also said that the liberalization 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.

A major reason for allowing foreign investment was the economic crisis of 1991. India started having balance of payments problems since 1985, and by the end of 1990, it was in a serious economic crisis. The government was close to default, its central bank had refused new credit and foreign exchange reserves had reduced to the point that India could barely finance three weeks’ worth of imports. In November 1995, SEBI notified the Foreign Institutional Investors Regulations which were largely based on the earlier guidelines issued in 1992. The regulations require FIIs to register with SEBI and to obtain approval from the Reserve Bank of India under the Foreign Exchange Regulation Act, 1973 to enable them to buy and sell securities, open foreign currency and rupee bank accounts and remit and repatriate funds. SEBI’s definition of FIIs presently includes foreign pension funds, mutual funds, charitable/endowment/university funds etc. as well as asset management companies and other money managers operating on their behalf. For calculating the FII investment limits, investments made through purchases of GDRs and convertibles are excluded.

Investments by NRIs and Overseas Corporate Bodies predominantly controlled by them, which were included earlier, are no longer included for purposes of monitoring the FII investment ceilings. If the company passes the resolutions increasing the limit from 24% to 49%, then only any FIIs can invest money in its shares beyond the limit of 24%. This is interesting, specially when the company management and the promoters can never be interested to allow any outsiders taking a substantial stake in the company, since that puts a lot of pressure on them and restricts their uninterrupted enjoyment of power within the company at the public money, while the investing public remains a silent spectator outside the company, not able to do anything. A foreign investor can safely adopt the FIPB approval route, if the company management and promoters favour the same.

In the light of the above, it is desirable that the Government may amend Foreign Exchange Management (Substantial Acquisition of Shares and Takeover) Rules bringing out consistency in the policies and provisions and providing a level playing field without any discrimination and in the overall interest of the investors. This would not only attract more foreign investment, but improve the level of corporate governance and performance too. 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.

Portfolio investments brought in by FIIs have been the most dynamic source of capital to emerging markets in 1990s.

At the same time there is unease over the volatility in foreign institutional investment flows and its impact on the stock market and the Indian economy. Number of registered FII’s 1756
Number of Registered sub accounts 6366 as on 17 .08.12
Financial Year Net Inflows from FIIs (in US$ Mn)

2001–02 1,839
2002–03 566
2003–04 10,005
2004–05 10,352
2005–06 9,363
2006–07 6,821
2007–08 16,442
2008–09 -9,837
2009–10 30,253
2010–11 32,226

The table reveals that net investment flows from FIIs significantly contributed to India’s balance of payments (BoP) during the period of the study. This is evident from the fact that the country received net portfolio flows of US$ 106 billion during the last decade, reflecting the growing international investors’confidence in India’s growth story.

Net FII inflows turned negative(net outflow of around US$ 10 billion) for the first time during 2008–09 mainly due to the global financial meltdown, which made foreign investors risk-averse and flee the country

Net investment flows from FIIs were around US$ 2 billion during 2001–02.The figure increased by more than 16 times and crossed US$ 32 billion during 2010–11, the highest so far in the history of the Indian capital market. The sharp rise in FII flows into India may be attributed to factors such as FIIs’search for higher yields in view of lower real returns in the advanced economies ,coupled with India-specific factors, viz., strong macro-economic fundamentals ,a deep, liquid and buoyant capital market, a diversified product portfolio including derivatives, a resilient financial sector, a sound regulatory regime, efficient payment and settlement systems, advanced risk management practices ,robust corporate financial performance, and the relatively attractive P-E ratios

It was found that net FII inflows and the BSE Sensex showed a significant positive correlation. It was further observed that there was good co-movement between FII inflows and foreign exchange reserves since India balances its current account deficit (CAD) on the one hand, and the foreign exchange kitty on the other hand, with the help of foreign currency inflows.

This is not unusual as most of the developing economies might be experiencing the same patterns. The increasing role of FIIs has brought in the development of our stock markets as well such as expansion of the business in securities, increased depth and breadth of the market, etc.

FIIs contribute to almost 13% of the entire market capitalization at National Stock Exchange in India. If we talk of FIIs investment, this has been continuously grown over years except 1998-99 and 2008-09 when FIIs sold more than they purchased in Indian stock market.

Individual Investors
Individual investors are those who trade in stocks and other securities for their personal portfolios, as opposed to institutional investors, such as mutual funds, insurance companies,and pension funds who trade through their corporate portfolios. In a simpler terms, Individual who purchases securities for himself/herself. Portfolio of individual investor consists of mutual funds, derivatives, shares, debentures bonds, bank deposits ,post office instrument, gold, real estate. Precautionary motive of investor has been recognized. Stock market has gained popularity during recent past years, Household investor participation increased, based on stock market index returns of 72 per cent in 2003 followed by 11 per cent in 2004, and growing confidence in the transparency and robustness of the market design which was put in place over the period 1993-2001.

A recent nationwide survey of over 60,000 households by National Council of Applied Economic Research (NCAER), New Delhi and Max New York Life has revealed that people in India do not plan for long-term future and keep away from investing in long-term instruments though they save for long-term goals such as emergencies, education and old age.

The survey reveals that most Indians prefer keeping 65 percent of their savings in liquid assets like bank or post office deposits and cash at home, while investing 23 percent in physical investments like real estate and gold and only 12 percent in financial instruments.

For getting secure return on their earning, 51 percent of Indians put their savings in the banks while 36 percent of households still prefer to keep cash at home. The investment in post offices and other guaranteed return schemes and plans gets minor part of total savings. Only 5 percent of family put their money in post offices, while 2 percent buy insurance policies and 0.5 percent invests in equities. Interestingly, though life insurance is among the most popular financial instruments (about 78 percent of the households are aware of life insurance), yet only 24 percent of households have a life insurance policy. The ownership is 38 percent among urban households but a low 19 percent among rural households.

According to the survey, a person’s occupation, education, age, location and landholding directly influence his or her income. Households with graduates earn 3.5 times more than those with illiterate ones, and incomes nearly double between the ages of 25 and 66. While salaried class households, which constitute only 18 percent of the total households in the country “accounted for greatest proportion of savings” and are the cream of urban India, agriculturists with land are the richest in rural areas. Wage laborers are the poorest anywhere, comprising 62 percent of the lowest-income households. The highest savings (in terms of per household) are in the 56-65 age group where savings are Rs.21,196 per household, or 25 percent of the annual income,” the study notes.

The two main factors responsible for higher savings with growing age, according to the survey, are motivation to save and the need to meet old-age requirements.

The survey also suggests a direct link between the education and savings by pointing out that households headed by graduates had highest level of savings in both absolute terms and as a percentage of income.

From the above survey it can be concluded that individual investments are influenced by many factors such as education, age, income etc, demographic ,psychological factors.

Survey by NCAER revealed the behaviour of individual towards investment ,various factors are taken into the consideration while investing the fraction of income. It has been seen more individual investors are attracting towards stock market.

China’s high growth and emergence in the world economy has been made possible in part by the willingness of its households to save a high fraction of their income.

Objective of the study

* To study the impact of FII on Individual investments in India

Individual investors follow the FII trends , Media reports , Newspaper .FIIs play major role in movement of stock prices, reduces cost of capital of companies thereby increases Earning per share .In Indian scenario ,heavy inflows in stock market lift two major stock exchanges BSE, NSE. Stock market lure the domestic investor. On the same token when FIIs take their money out Indices go down .FII has been taken into the consideration ,however many other factors affect the economy and investment decisions of the individual investor.

Objective is to study the single major factor FIIs impact on individual investment decisions Given the scenario FIIs invests in the Indian market through Equity ,debt , Mutual funds, Bonds ,Goverment Bonds .These areas are affected by FIIs, liquidity in the market increases Heavy inflows put inflationary pressures which leads to change in monetary policy .RBI cuts CRR, increases bank rate to attract the deposits form general public. FIIs are one of the factors in fluctuating the exchange rate. Through foreign investment in banks shares increases the liquidity and efficiency of banks results in smooth functioning of banks.

Banks further invest public funds in financial markets. There is indirect effect of FIIs on individual’s investment decisions. FIIs generate liquidity in the market , a well developed financial system accelerate economic growth .

Importance: To what extent FIIs are beneficial for Indian economy.

Research question :
How much FIIs impact the behaviour of individual in investing the funds in stock market and other sectors of investments. Do Foreign capital increases or decreases the pace of individual investment ?

* To find the relationship between Individual investment and economic growth Another objective of the study is to find out the relationship between individual investment and economic growth.

Research question

How does individual investment in various sectors affect economic growth?

* To analyse the contribution of individual investor in strengthening the financial Market

Another objective of the study is to analyse the changes in the composition of investor’s portfolio whether he deploys more funds to the equity market which strengthen the stock market , more liquidity in the stock market. To analyse the composition of individual investments in stock market and other sectors of investments.

For a strong financial system it is necessary to channelling funds from individuals in surplus to those who are in need of funds to expand business . Keeping larger amount of cash idle may be hurdle in economic growth and sound financial system Importance: Through this objective policies need to design to attract more capital domestically.

Research Question

Which sector should be encouraged for individual investments to strengthen the financial markets

* Developing Model inter-connected with FII, domestic investor and economic growth.

Objective of this research is to develop a model showing how interconnected are the foreign capital, domestic capital and economic growth. How these factors are interdependent on each other.

Rationale of the study

Researchers have explained the relationship between FII on the stock market with reference to stock indices BSE as explained in the above literature. It has also explained by researchers the impact of individual investors and volatility of stock returns.

In this research we attempt to analyse the indirect impact of foreign Capital on individual investment ,individual investor may or may not be aware the impact of foreign capital and contribution of individual investment to economic growth .

It is important to study the behaviour of individual investors. They also play significant role in strengthening the financial system and contributors in economic growth .

If it is proved through this study that FII impact individual investment and increase or decrease in individual investment impact economic growth, policy needs to design to attract domestic capital to stimulate economic growth.

A remarkable feature of modern financial markets is the huge amount of trade that is carried out not only by institutions who have informational advantage in trading but also by individual investors who are likely to be less knowledgeable about financial markets

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