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K.K.Verma(ed)Management Perspectives in New Millennium(New Delhi:

Dilpreet Publishing House) 2011,pp. 1-10.

MANAGING FIIs INFLOWS INTO INDIA: SOME

OPTIONS
R.K.Srivastava*
Abstract: Being on the most attractive emerging economy, India has attracted a large chunk of
portfolio funds. A number of reasons including Indias growth story, interest rate differentials
between emerging and developed economies, etc have been cited to FIIs inflows into India. At a
given point of time the economy has the capacity to absorb only a given amount of capital.
Capital inflows in excess of that can create problems. However, there are some options available
in the hands of Government and RBI to manage this situation prudently.
Key words: Foreign Institutional Investors(FIIs), Foreign Direct Investment(FDI), capital
inflows, financial integration, emerging economies, growth story, appreciation, depreciation,
liquidity, Cash reserve ratio(CRR), Tobin tax, participatory notes(PNs), stimulus packages.

I. INTRODUCTION
Foreign Institutional Investors (FIIs) investment can take place in a variety of ways like
in shares and bonds; long-term forex loans; and short-term forex loans. The beneficial
effects of FIIs are somewhat indirect and not as visible in the case of FDI. FII inflows too
help capital formation either by participating in public offerings or by releasing the
existing pool of risk capital through secondary markets. There is a general fear that FIIs
can reverse at any time (Srivastava, 2005). Therefore, portfolio investment is called hot
money.
The linkages that FIIs provide have their pros and cons. They have brought heterogeneity
to the Indian markets (as FIIs come in all colors and shapes), improved governance
quality and made the markets more efficient. But the down-side is that they link India to
global markets and bring some of the riskier global practices into the Indian markets as
India is experiencing currently. In the meantime, India increasingly has integrated with
global markets (Shah, 2008). However, the strong increase in net private capital inflows
to the emerging market economies over the past few years is proving to be a mixed
blessing. Although these flows help deliver the benefits of increased financial integration,
they also create challenges for policymakers because they can lead to over heating, a loss
of competitiveness and increased vulnerability to crisis. While a number of studies have
examined the policy responses to capital inflows in the 1990s, focusing on a limited
number of country cases, there have been fewer studies involving recent episodes of
capital flows and even fewer attempts to systematically compare how different countries
have responded in terms of new policies ( Cardarelli, 2007).

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Being on the most attractive emerging economy at present, India has attracted a large
chunk of portfolio funds. The major issues and concerns are (The Economic Times,
19.11.09):

India runs a large trade deficit because of the huge oil imports. The country also
needs foreign capital to step-up investments
In that sense foreign capital inflows are vital to the economy
However, at a given point of time the economy has the capacity to absorb only a
given amount of capital

Capital inflows in excess of that can create problems.

India has already attracted portfolio inflows of over $16 billion in 2009 calendar year so
far against $20 billion in 2007. FDI in April-September 2009 was $17.74 billion against
$35.2 billion in 2007-08. Over rising capital inflows into India, it looks it imperative in
short-term as well as in medium term that a far-reaching implications may take place in
the Indian economy. Therefore, the main objective of the paper is to identify the options
what India can take to manage the situation.
----------------------------------------------------------------------------------------------------------*Prof. of Economics,HNB Garhwal University ,Campus Badshahithaul, Tehri (Garhwal )
II.TRENDS
India has been a key beneficiary of the improvement in sentiments towards emerging
markets and this is reflected in the large FII inflows in 2009. FIIs presence in the Indian
markets is deep rooted which has emerged the following trends:
(i) Year-wise: Net purchases of the Indian shares by FIIs have topped the $16 billion
mark for current calendar year (2009) and market watchers say a depreciating dollar
could drive more money into emerging markets like India in the near term, as global
investors try to maximize returns. In 2007, foreign funds net pumped in a record $20
billion in Indian shares (The Economic Times, 17.11.09).The large scale foreign portfolio
funds have flowed into emerging markets because of flood of liquidity in the global
markets. Table1 shows that foreign investors have given weight age to the Indian
markets by deploying more funds.
Table 1: FII inflows into India
Year

Amount($billion)

2006
2007
2008
2009

9.00
20.00
-9.36
16.04

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(ii) Sector-wise: FII holdings are 25.6%, 25.4%, 18.6% and 17.9% respectively in
Agrochemicals, Real Estate, Breweries and Mining sectors. Companies where FIIs
holdings are increased: United Phosphorus, United Spirits, Gujarat NRE Coke, Sesa Goa,
DLF,Unitech, Indiabulls Real Estate, HDIL, etc. On contrary, technology, capital goods,
cement and retail are the sectors where FIIs holdings are decreased. Combined FII
holdings in the listed IT companies fell to 12.1% as on September 30, 2009. Their
exposure in capital goods sector fell to 9.9% from 12.1% and to 15.1% from18.5 in retail
space. Table 2 shows that FIIs have re-balanced their holdings among sectors in India.
Table2: FII holdings as % of combined equity of all Companies in each sector
Sector

Sept.2009

Sept.2009

Sept.2007

Agrochemicals
Real Estate
Breweries
Mining
Banks
Finance
Construction
Retail
FMCG
Cement
InfoTech
Automobiles
Capital goods

25.6
25.4
18.6
17.9
16.4
16.4
16.2
15.1
13.3
13.2
12.1
10.7
9.9

23.6
9.6
21.1
18.0
17.6
14.0
14.3
18.5
12.8
14.0
15.6
10.4
12.1

20.5
10.3
22.7
20.7
19.5
19.1
19.2
18.9
12.7
17.2
15.7
13.0
12.2

(iii) Company-wise: FIIs holding and share price movement have a strong positive
correlation. Stock prices of companies where FIIs increased their holding in September
quarter09 rose 32% on an aggregate during the period. Shares of companies, where FIIs
holding remained the same and declined, appreciated 18% and 16% respectively (Table
3).
Table 3: Corporations where FIIs stake
FII holdings

Return (%)

Went up
Remained same
Declined

32.26
17.85
16.02

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Returns between June 30 and Sept 30,2009
Source: CMIE Database
Top five companies, which attracted FIIs the most, are HDIL, Sobha Developers,
Hindustan Construction Company (HCC), Indiabulls Financial Services and Orbit
Corporation. Most of these companies are engaged in construction and infrastructure
related works which suffered the worst during the credit crisis. In HDIL, foreign holdings
rose to 26.01% from 7.05% in June08. Similarly, Sobha Developers saw its FIIs holding
going up to 18.68% from 2.54 during the same period (The Economic Times, 1.11.09).
III. REASONS
A number of reasons have been cited to FIIs inflows into India in a large proportion. The
prime movers are:
(i) Indias growth story: India, Asias third-largest economy, has suffered less in the
global downturn than developed countries. The economy is likely to grow 6.5 % in 200910, after growing 6.7% in 2008-09. Its growth story is now more compelling than ever
before. It was not hit hard by the crisis, it continues to draw support from a micro story
(which means large collection of world class companies) and FDI and infrastructure
still a major constraintare moving up from the bottom. More importantly, the political
equation is now much more constructive for reforms (Roach, 2009). Clearly, due to the
greater growth prospects of the Indian economy along with a favorable market and
currency condition, FIIs have attracted to India. This high and regular FIIs inflows into
India are quite good phenomena for the country, as it will help to better fund its
infrastructure and capital goods. Moreover, this increased flow will help the government
to finance the current account deficit for 2010 estimated at US$ 25 billion or two per cent
of GDP.
On the other hand consensus is that recovery in the US and Europe will be slow and
gradual. The global perception is that emerging markets are the best equity asset class.
Therefore, there is a lot of foreign money chasing growth opportunities in the emerging
economies including India.
(ii) Rate of interest: Near-zero interest rates in the US, Britain and Japan are depressing
the dollar and fueling a surge in asset prices. Widening interest rate differentials between

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emerging and developed economies is one of the most important factor has compounded
the capital surge in emerging Asian countries including India, as returns from such flows
have become more attractive. Clearly, the cost to borrow dollar is lower than to investing
in emerging economies. For example, LIBOR rates are at 3% and emerging markets bond
spreadsthe differential between government bond yield and corporate bond yieldsare
down from 800 bps at the peak, to 300bps. So, in essence, the emerging market risk is
coming down which is a comfort zone for a foreign fund management to increase
exposure to emerging markets.
Interest rate differentials in the world markets, already favoring emerging markets and so
attracting investment flows, are set to expand further. The consequent impact on forex
market is that rupee has appreciated. For instance, rupee has appreciated about 12% from
early March 2008, making exports less competitive. Exports, which make about one-fifth
of Indias GDP, have been falling since October 2008. For the export-led companies,
rupee appreciation may be bad phenomenon. Thus, it affects the fortunes of these
companies.
More importantly, the US, the euro zone, Japan and Britain are showing no inclination to
push up their rates anytime soon as recovery proves slow. Rising inflows have helped
drive up stock and property prices in India promoting the RBI to increase provisioning
requirements for loans to real estate companies to asset bubbles. The RBI is already
worried about inflation but has limited monetary tools to tame price rises. The RBI has
said there is a risk that if it raised interest rates ahead of other Central Banks, it could
attract more inflows and complicate policy making.
IV. OPTIONS
A large chunk of high forex inflows particularly through the FII route have been posing a
challenge to the RBI. If capital inflows continue to maintain their current momentum, the
policy makers will have to initiate some more capital control measures. The options in the
hands of RBI are:
(i)

RBI does not want to leave such large capital inflows fueling the domestic
liquidity which create inflationary pressures in the economy. Therefore, RBI is
forced to suck excess liquidity in the system through issues of bonds to

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control money supply and check inflation. This is called sterilization, but it
pushes up interest rates which will increase governments borrowings costs.
Raising the cash reserve ratio (CRR), it could also discourage capacity of
bank lending.
(ii)

The government should have improved absorption of liquidity arising on

account of large capital inflows. It should increase infrastructure sector
investments either through increasing budgetary allocation and/or encouraging
the private sector to accelerate investments in this area by improving the
regulatory environment.

(iii)

It is advocated that some sort of Tobin tax on foreign capital flows is

desirable. James Tobin, Nobel Prize winning economist, had proposed this tax
on forex flows in 1971. During the 1997 Asian crisis, Malaysia had
successfully experimented to it. Recently, Brazilian government has imposed
a 2% tax on all foreign exchange inflows. But in India in some quarters it is
considered as retrograde and impractical step.

(iv)

Government can restrict Participatory Notes (PNs) in the Indian markets. PNs
are derivative instruments whose underlying securities are Indian stocks.
These are issued by FIIs to overseas investors who want to invest in Indian
stocks but are not allowed to do so (Srivastava, 2006).

(v)

The government could also cap overseas borrowings of Indian companies by

auctioning quotas for foreign credit, which would raise the cost of raising
funds.

However, there are some policy dilemmas before the RBI:

In 2009-10 capital inflows are already of the order of 2007 and the RBI is
struggling to find the right response

There is too much money in the system

RBI has already hiked its March 2010 inflation estimate to 6.5% from 5%
earlier

The rupee has already appreciated sharply

Despite low interest rates credit growth has not picked up

RBI should be hiking interest rates but cannot do so unilaterally at this

stage at that could cause even larger capital inflows

RBI left key interest rates unchanged in its October 27,2009 review of
monetary policy

V. CONCLUSION
The free flow of capital is the life-blood of sustainable economic growth and expanding
prosperity. FIIs inflows are an attractive device which assists to globalize the domestic
companies. But its pitfalls are also well known, any time portfolio money can fly into
another destination. It has been seen in the world economic crisis 2007 and 2008 when
portfolio investments had been pulled back suddenly in large scale from stock exchanges.
Their affects were havoc in capital markets. Again FIIs are more active in emerging
economies since April 2009 and are pumping more money in these markets including
India. A number of associated problems of large scale FIIs inflows into India are:

Sharp increase in money supply

Inflation

Monetary management become difficult, interest rates would have to be hiked,

affecting recovery

Rupee would tend to appreciate, making exports less competitive as rupee income
of exporters from the same amount of dollars will fall.

Indias growth story is the prime reason to FIIs inflows into it in the large proportion. It is
primarily driven by domestic consumption which looks to the global investors more
convincing and stable. India is considered as a land of opportunities; therefore,
international community cannot want to miss it. Stimulus packages, provided by the
governments, have created ample liquidity in the markets. It is being deployed by foreign
investors in stock and commodity markets in emerging economies including India. To
avoid the repercussion of the excess FII inflows into India, a number of conventional and
non-conventional measures have been suggested to cut the ice.
Reference:

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Breathing easy for now, but Govt. may choke Inflow if need be The Economic Times,
19.11.2009.
Cardarelli, Roberto, et al, Learning how to cope with big Capital Inflows, IMF
Survey,Nov.2007.
FII Shopping bring at $15 B and Counting The Economic Times, 17.11.2009.
High FII holdings are key to Stock price rise The Economic Times, 1.11.2009.
Roach, Stephen, The Indian Growth Story is more Compelling, The Economic Times,
2.11.2009.
Shah, Rajesh, 2008, Can Domestic Players support Stock Market? The Economic
Times,28.10.2009.
Srivastava, R.K., 2005, FII inflows into India: A Dilemma, IBA Bulletin, July 2005.
Srivastava, R.K.,2006, Rupee Volatility in Forex Market: Some Dimensions, Southern
Economist, May 1,2006.