macroeconomicbusinessenvironment macroeconomicbusinessenvironment macroeconomicbusinessenvironment macroeconomicbusinessenvironment MACRO ECONOMIC macroeconomicbusinessenvironment BUSINESS macroeconomicbusinessenvironment ENVIRONMENT FOREIGN INSTITUTIONAL macroeconomicbusinessenvironment INVESTMENTS macroeconomicbusinessenvironment

(TERM PROJECT) macroeconomicbusinessenvironment macroeconomicbusinessenvironment macroeconomicbusinessenvironment macroeconomicbusinessenvironment macroeconomicbusinessenvironment macroeconomicbusinessenvironment macroeconomicbusinessenvironment macroeconomicbusinessenvironment
Foreign Institutional Investments

SUBMITTED TO:

COMPILED BY:

Prof. Binilkumar Amarayil Sreeraman,

Richa Sharma, Seat No. - 06

Shilpa Jacob P., Seat No. - 21 Deepam Jain, Seat No. - 29

ICFAI Business School, Hyderabad.

Mannika Agarwal, Seat No. - 34 Rohan Roy, Seat No. - 37

Anil K Pathak, Seat No. - 73 Section K,

ICFAI Business School, Hyderabad.

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Table of Contents
1. INTRODUCTION .................................................................................................................... 3 1.1. 1.2. 1.3. 2. 2.1. 2.1.1. 2.1.2. 2.1.3. 2.1.4. 2.2. 2.2.1. 2.2.2. 2.2.3. 2.2.4. 3. 4. 5. 5.1. 5.2. 5.3. 5.4. 5.5. 5.6. 5.7. 5.8. 6. 7. 8. 9. 10. Foreign direct investment............................................................................................ 3 Foreign institutional investment................................................................................... 4 Benefits of FII in India................................................................................................ 5 ENTRY OPTIONS FOR FII IN INDIA .............................................................................. 6 Normal FIIs ............................................................................................................... 6 Preferential Allotment of Shares .......................................................................... 6 Qualified Institutions Placements (QIPs) .............................................................. 8 FCCB ................................................................................................................ 9 INITIAL PUBLIC OFFERING............................................................................ 9 100% Debt FIIs........................................................................................................ 10 As FIIs............................................................................................................. 10 As Sub-accounts ............................................................................................... 13 Domestic entity................................................................................................. 13 PARTICIPATORY NOTES .............................................................................. 13

REGULATIONS IMPOSED BY INDIAN GOVERNMENT ON FII.................................. 15 REASONS FOR THE ATTRACTIVENESS OF INDIAN ECONOMY FOR FII ................ 17 EFFECT OF FII ON INDIAN MONETARY POLICY ...................................................... 19 Appreciation of The Currency ................................................................................... 19 Depreciation of the Currency .................................................................................... 20 FII and exports ......................................................................................................... 20 FII and stock market................................................................................................. 21 FII and inflation ....................................................................................................... 21 FII and local companies ............................................................................................ 22 Capital formation in domestic market ........................................................................ 22 FII and the Hot Money Concept ................................................................................ 22 IMPACT OF FII ON THE FISCAL POLICY OF INDIA ................................................... 24 FIIS AND THE INDIAN STOCK MARKET.................................................................... 25 FOREIGN INVESTMENT FLOWS IN INDIA ................................................................. 26 TRENDS IN FII INVESTMENT IN INDIA...................................................................... 29 BIBLIOGRAPHY........................................................................................................ 31

Foreign Institutional Investments

1. INTRODUCTION
Foreign investment refers to investments made by the nationalist of a country in the nancial assets and production processes or directly in the stock market of another country. After the opening up of the borders for capital movement, these investments ha ve grown in number at a exponential rate. The effect of foreign investment, however, varies from country to country on the bases of both economical and political factors affecting that country. It can affect the factor productivity of the recipient country and can also affect the balance of payments. In developing countries like India which is the second fastest growing, there has been a great need for foreign capital, not only to increase the productivity of labor but also because foreign capital helps to build up the foreign exchange reserves needed to meet trade decits which is export minus imports. Foreign investment provides a channel through which developing countries can gain access to foreign capital. It can come in two forms: Foreign direct investments(FDI) Foreign institutional investment (FII).

1.1.Foreign direct investment :- It involves in direct production activities and is also of a

medium- to long-term nature. Foreign direct investment (FDI) or foreign investment refers to long term participation by a country into another country. It usually involves participation in management, joint-venture, transfer of technology and expertise. India has been ranked at the third place in global foreign direct investments in 2009 and will continue to remain among the top five attractive destinations for international investors during 2010-11. Foreign direct business relationships give rise to multinational corporations. For an investment to be regarded as an FDI, the parent firm needs to have at least 10% of the ordinary shares of its foreign affiliates. The investing firm may also qualify for an FDI if it owns voting power in a business enterprise operating in a foreign country. DIs can be broadly classified into two types: outward FDIs and inward FDIs. This classification is based on the types of restrictions imposed, and the various prerequisites required for these investments.

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1.2.Foreign institutional investment is a short-term investment, mostly in the nancial

markets. FII, given its short-term nature, can have returns of other domestic nancial markets such as money markets, stock markets, and foreign exchange markets. Hence, understanding the determinants of FII is very important for any emerging economy as FII exerts a larger impact on the domestic nancial markets in the short run and a real impact in the long run. This project examines the determinants of foreign institutional

investment in India, a country that opened its economy to foreign capital. India has taken many measures to attract foreign investment since the beginning of reforms in 1991. Up to the end of January 2003, India succeeded in attracting a total foreign investment of around U.S.$48 billion out of which U.S.$12 billion was in the form of FII. India is in the process of liberalizing its capital account, and this has a signicant impact on foreign investment and particularly on FII, which affects short-term stability in the nancial markets.

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1.3.Benefits of FII in India: Imparting stability to India's Balance of Payme nts For promoting growth in a developing country such as India, there is need to augment domestic investment, over and beyond domestic saving, through capital flows. The excess of domestic investment over domestic savings result in a current account deficit and this deficit is financed by capital flows in the balance of payments. Knowledge flows The actions of foreign institutional investors help strengthen Indian finance. FIIs Embedded modern ideas in market design, promote innovation, development of sophisticated products such as financial derivatives, enhance competition in financial intermediation. Strengthening corporate governance FIIs, with their vast experience with modern corporate governance practices, are less tolerant of malpractice by corporate managers and owners (dominant shareholder). FII participation in domestic capital markets often lead sound corporate governance practices, improved efficiency and better shareholder value. Improvements to market efficiency A significant presence of FIIs in India can improve market efficiency through two channels. First, when adverse macroeconomic news, such as a bad monsoon, unsettles many domestic investors, it may be easier for a globally diversified portfolio manager to be more stable about India's prospects, and engage in stabilizing trades. Second, at the level of individual stocks and industries, FIIs may act as a channel through which knowledge and ideas about valuation of a firm or an industry can more rapidly propagate into India.

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2. ENTRY OPTIONS FOR FII IN INDIA

FIIs (Foreign Institutional Investors) have been permitted to invest in all types of securities including govt. securities. The investments by FIIs enjoy full capital account convertibility. They can invest in a company under portfolio investment route up to 24% of the paid up capital of the company. This can be increased up to the statutory ceiling, as applicable. The recent initiatives by the Government for developing the corporate debt market, increasing the ceiling on investment by FIIs in the domestic debt market and move towards convertibility of rupee in the capital account are the positive factors, which have increased the FII inflows in the country. FII investments in India can be of the two types:

2.1.Normal FIIs : FII allocation of the total investment between equity and non-equity
instruments (including dated government securities and treasury bills in the Indian capital market) should not exceed the ratio of 70:30. Equity related instruments would include fully convertible debentures, convertible portion of partially convertible debentures and tradable warrants. The FII inflows into the primary market in India comes mainly through the conversion of foreign Currency conve rtible bonds (FCCBs), private placement to qualified institutions place ments (QIPs), initial public offers (IPOs), follow-on overseas offers, conversion of warrants and preferential offers.

2.1.1. Preferential Allotment of Shares

Every firm needs capital for investment. They need capital to meet expenditure like expansion, diversification, modernization, M&A, etc., from time to time. When a listed company doesn't want to go for further public issue and the objective is to raise huge capital by issuing bulk of shares to selected group of people, preferential allotment is a good option. A private placement is an issue of shares or of convertible securities by a company to a select group of persons under Section 81 of the Companies Act, 1956 which is neither a rights issue nor a public issue. This is a faster way for a company to raise equity capital.

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A private placement of shares or of convertible securities by a listed company is generally known by name of preferential allotment. A listed company going for preferential allotment has to comply with the requirements contained in Chapter XIII of SEBI (DIP) Guidelines, in addition to the requirements specified in the Companies Act. In short, preferential issue means allotment of equity to some selected people by a company which has its share already listed. Advantages One advantage of raising money via a preferential issue is that it helps save cost and time involved in a public issue. If the concerned company is not doing too well at that point in time but requires capital, then retail investors may not want to participate in an issue. At the same time, there could be some institutions which view the company's troubles as being temporary and feel that some injection of capital could help it out of the trough. In fact, promoters need such investors in times when the market sentiment is weak and a public issue could fail. Moreover, if promoter is being allotted preferential issue and they acquire more shares in the company, it is a good sign because it shows that the corporate ship is not sinking and they have abiding interest in the company. There is no require ment of filing any offer docume nt / notice to SEBI in case of the preferential allotment and even no eligibility norm for the company for the preferential allotment. In the preferential allotment, these are issued in bulk and, hence, when huge fund requirement is there without incurring much cost and without investing much time. In current scenario, where there is lots of takeover in preferential issues, the shares are issued to friendly investors like promoters to ward-off the risk of take over. If shares are issued to public, there is a chance that later they can sell it to a firm which has an intension of take over.

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2.1.2. Qualified Institutions Placements (QIPs)

Primarily an issue can be classified as public issues, rights and private placements (also known as preferential issues). QIPs are issued under the category of private place ments. A private placement is an issue of shares or of convertible securities by a company to a select group of persons under Section 81 of the Companies Act, 1956 which is neither a rights issue nor a public issue. This is a faster way for a company to raise equity capital. A private placement of shares or of convertible securities by a listed company is generally known by name of preferential allotment. A Qualified Institutions Placement is a private placement of equity shares or securities convertible into equity shares by a listed company to Qualified Institutions Buyers only in terms of provisions of Chapter XIIIA of SEBI (DIP) guidelines. The chapter contains provisions relating to pricing, disclosures, currency of instruments etc. There are no eligibility norms for a listed company making a preferential issue. However for Qualified Institutions' placement (QIP), only those companies whose shares are listed in NSE or BSE and those who are having a minimum public float as required in terms of the Listing agreement are eligible. Advantages Investors subscribing to shares in relation to preferential allotment face a one year lock- in period. The securities allotted pursuant to the QIP Scheme also cannot be sold by the allotees for a period of one year from the date of allotment but they can still do the same on a recognized stock exchange (even within one year). This provision allows the investors an exit mechanism on the stock exchange without having to wait for a minimum pe riod of one year. This advantage has also added to the preferential treatment received by QIPs from investors. Not more than 50 pe r cent of the equity can go to one investor. As such mutual funds that are increasingly becoming as large an investor base as FIIs, will now be able to participate in these issuances, thereby, creating a more level playing field.

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As per SEBI guidelines, place ments can be made only to the qualified institutions buyers which includes FIIs, SEBI-registered venture capital funds, mutual funds, insurance companies and other institutional investors and issuers would have to allocate a minimum of 10 per cent of such placements to mutual funds. Promoters or those related to the issuers are barred from participating in such issues.

2.1.3. FCCB
It is a type of convertible bond issued in a currency different than the issuer's domestic currency. In other words, they are raised by the issuing company is in the form of a foreign currency. A convertible bond is a mix between a debt and equity instrument. It acts like a bond by making regular coupon and principal payments but these bonds also give the bondholder the option to convert the bond into stock. These are the debt instrument issued in a currency different than the issuers domestic currency with an option to convert them in common shares of the issuer company. It is a quasi debt instrument that helps companies raise foreign currency funds at attractive rates. FCCBs are similar to bonds as they make regular coupon (interest) payments and also give the bondholder an option to convert the bond into stock. Advantages These types of bonds are attractive to both investors and issuers. The investors receive the safety of guaranteed payments on the bond and are also able to take advantage of any large price appreciation in the company's stock. (Bondholders take advantage of this appreciation by means warrants attached to the bonds, which are activated when the price of the stock reaches a certain point.)

2.1.4. INITIAL PUBLIC OFFERING

Public issues can be classified into Initial Public offerings and further public offerings. In a public offering, the issuer makes an offer for new investors to enter its shareholding family. The issuer company makes detailed disclosures as per the DIP guidelines in its offer document and offers it for subscription. Initial Public Offering (IPO) is when an unlisted company makes either a fresh issue of securities or an offer
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for sale of its existing securities or both for the first time to the public. This paves way for listing and trading of the issuers securities. IPO is new shares Offered to the public in the Primary Market .The first time the company is traded on the stock exchange. A prospectus is issued to read about its risk before investing. IPO is a company's first sale of stock to the public.

2.2.100% Debt FIIs

FII that can invest the entire corpus in dated government securities including treasury bills, non-convertible debentures/bonds issued by an Indian company subject to limits, if any. A FII needs to submit a clear statement that it wishes to be registered a s FII/subaccount under 100% debt routes. Curre ntly, entities eligible to invest unde r FII route are as follows :

2.2.1. As FIIs :
Overseas pension funds, mutual funds, investment trust, asset Management Company, Nominee Company, bank, institutional portfolio mana ger, and 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 (i.e., fund having more than 20 investors (with no single investor holding more than 10 per cent of the shares or units of the fund). Some of the above mentioned types are described below:

2.2.1.1.

Pension funds A pension fund is a pool of assets that form an independent legal entity that are bought with the contributions to a pension plan for the exclusive purpose of financing pension plan benefits. It manages pension and health benefits for employees, retirees, and their families. FII activity in India gathered momentum mainly after the entry of CALPERS (California Public Employees Retirement System), a large US-based pension fund in 2004.

2.2.1.2.

Mutual funds A mutual fund is a professionally managed type of collective investment scheme that pools money from many investors and invests it in stocks, bonds,

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short-term money market instruments, or other such securities. The mutual fund will have a fund manager that trades the pooled money on a regular basis. The net proceeds or losses are then distributed to the investors.

2.2.1.3.

Investment trust An Investment trust is a form of collective investment .Investment trusts are closed-end funds and are constituted as public limited companies. A collective investment scheme is a way of investing money with others to participate in a wider range of investments than feasible for most individual investors, and to share the costs and benefits of doing so

2.2.1.4.

Investment banks An investment bank is a financial institution that raises capital, trades in securities and manages corporate mergers and acquisitions. Investment banks profit from companies and governments by raising money through issuing and selling securities in capital markets (both equity, debt) and insuring bonds (e.g. selling credit default swaps), as well as providing advice on transactions such as mergers and acquisitions.

2.2.1.5.

Hedge funds A hedge fund is an investment fund open to a limited range of investors that is permitted by regulators to undertake a wider range of investment and trading activities than other investment funds, and that, in genera l, pays a performance fee to its investment manager. Every hedge fund has its own investment strategy that determines the type of investments and the methods of investment it undertakes. Hedge funds, as a class, invest in a broad range of investments including shares, debt and commodities. Many hedge funds investments in India were facilitated by global investors borrowing at near zero interest rates in Japan and investing the proceeds in High interest markets like India.

2.2.1.6.

University Fund The purpose of investments of these funds is to establish an asset mix for each of the University funds according to the individual funds spending obligations, objectives, and liquidity requirements. It consists of the
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Universitys endowed trust funds or other funds of a permanent or long-term nature. In addition, external funds may be invested including funds of affiliated organizations and funds where the University is a beneficiary.

2.2.1.7.

Endowment fund It is a transfer of money or property donated to an institution, usually with the stipulation that it be invested, and the principal remain intact in perpetuity or for a defined time period. This allows for the donation to have an impact over a longer period of time than if it were spent all at once.

2.2.1.8.

Insurance Funds An insurance company's contract may offer a choice of unit-linked funds to invest in. All types of life assurance and insurers pension plans, both single premium and regular premium policies offer these funds. They facilitate access to wide range and types of assets for different types of investors.

2.2.1.9.

Asset Management Company An asset management company is an investment management firm that invests the pooled funds of retail investors in securities in line with the stated investment objectives. For a fee, the investment company provides more diversification, liquidity, and professional management consulting service than is normally available to individual investors. The diversification of portfolio is done by investing in such securities which are inversely correlated to each other. They collect money from investors by way of floating various mutual fund schemes.

2.2.1.10.

Nominee Company Company formed by a bank or other fiduciary organization to hold and administer securities or other assets as a custodian (registered owner ) on behalf of an actual owner (beneficial owner) under a custodial agreement.

2.2.1.11.

Charitable Trusts or Charitable Societies A trust created for advancement of education, promotion of public health and comfort, relief of poverty, furtherance of religion, or any other purpose regarded as charitable in law. Benevolent and philanthropic purposes are not

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necessarily charitable unless they are solely and exclusively for the benefit of public or a class or section of it. Charitable trusts (unlike private or noncharitable trust) can have perpetual existence and are not subject to laws against perpetuity. They are wholly or partially exempt from almost all taxes.

2.2.2. As Sub-accounts
The sub account is generally the underlying fund on whose behalf the FII invests. The following entities are eligible to be registered as sub-accounts, viz. partnership firms, Private company, public company, pension fund, investment trust, and individuals.

2.2.3. Domestic entity

A domestic portfolio manager or a domestic asset management company shall also be eligible to be registered as FII to manage the funds of sub-accounts.

2.2.4. PARTICIPATORY NOTES

Another way of investing in the Indian market through FIIs is through the use of PARTICIPATORY NOTES. Participatory notes (PNs) are instruments used by foreign funds, not registered in the country, for trading in the domestic market. They are a derivative instrument issued against an under lying security which permits the holder to share in the capital appreciation/income from the underlying security. PN s are like contract notes and are issued by FIIs, registered in the country, to their overseas clients who may not be eligible to invest in the Indian stock markets. PNs are used as an alternative to sub-accounts by ultimate investors generally based on considerations related to transactions costs and recordkeeping overheads. FIIs invest funds on behalf of such investors, who prefer to avoid making disclosures required by various regulators. The associates of these FIIs generally issue these notes overseas. The investors, who buy these notes, deposit their funds in the US or European operations of the FII, which also operates in India. The FII then buys stocks in the domestic market on behalf of these investors on their proprietary account. In this case, the FII or the broker acts like an exchange: it executes the trade and uses its internal accounts to settle the trade. This helps keeping the investor's name anonymous. Other such instruments include equity - linked notes, capped return note, participatory return notes and investment notes. Some genuine foreign investors often find it expensive to
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establish broker and custodian bank relationships, deal in foreign exchange, pay taxes and/or filing, obtain or maintain an investment identity or regulatory approval in certain markets, where their total exposure is not going to be very large. Such investors look for derivative solution to gain exposure in individual, or a basket of, stocks in the relevant market. The PN mechanism is favored by investors on grounds of lower transactions costs and overheads. Sometimes, investors embark on investment in India in a small way using PNs, and when their positions become larger, they find it advantageous to shift over to a full- fledged FII structure.

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3. REGULATIONS IMPOSED BY INDIAN GOVERNMENT ON FII

There are several regulations imposed by SEBI on Foreign Institutional Investments under Foreign Institutional Investors Regulations 1995. Following are some of important regulations by SEBI: 1. A Foreign Institutional Investor may invest only in the following: Securities in the primary and secondary markets including shares, debentures and warrants of companies [unlisted] listed or to be listed on a recognized stock exchange in India. Units of schemes floated by domestic mutual funds including Unit Trust of India, whether listed on a recognised stock exchange or not. Dated Government securities. Derivatives traded on a recognised stock exchange. 2. The total investments in equity and equity related instruments (including fully convertible debentures, convertible portion of partially convertible debentures and tradable warrants) made by a Foreign Institutional Investor in India, whether on his own account or on account of his sub- accounts, should be at least seventy per cent of the aggregate of all the investments of the Foreign Institutional Investor in India, made on his own account and through his sub-accounts. 3. In respect of investments in the secondary market, the following additional conditions shall apply:a. the Foreign Institutional Investor shall transact business only on the basis of taking and giving deliveries of securities bought and sold and shall not engage in short selling in securities. b. No transactions on the stock exchange shall be carried forward. c. The transaction of business in securities shall be only through stock brokers who have been granted a certificate by the Board under sub-section (1) of section 12 of the Securities and Exchange Board of India Act, 1992. d. A Foreign institutional Investor or a sub-account having an aggregate of securities which are worth rupees ten crore or more, as on the latest balance sheet date, shall, subject to such instructions as may be issued from time to
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time by the Board, settle their transactions entered on or after January 15, 1998, only through dematerialized securities. ] 4. The limit for cumulative debt investment for FII investments in Corporate Debt is USD 15 billion. This amount was changed from USD 6 billion to USD 15 billion in March 2009. 5. USD 8 billion will be allocated to the FIIs and Sub-Accounts through an open bidding platform while the remaining amount is allocated on a first come first served basis subject to a ceiling of Rs.249 cr. per registered entity. 6. The debt investment limit for FIIs in government debt in G-secs currently capped at $5 billion and cumulative investments under 2% of the outstanding stock of G-secs and no single entity can be allocated more than Rs. 1000 cr of the government debt limits. 7. Unless otherwise approved by the Board, securities shall be registered a. In the name of the Foreign Institutional Investor, provided the Foreign Institutional Investor is making investments on his own behalf; or b. In his name on account of his sub-account, or in the name of the sub-account, in case he is investing on behalf of the sub-account: provided that the names of the sub-accounts on whose behalf the Foreign Institutional Investor is investing are disclosed to the Board by the Foreign Institutional Investor. 8. The purchase of equity shares of each company by a Foreign Institutional Investor investing on his own account shall not exceed ten percent of the total issued capital of that company. 9. In respect of a Foreign Institutional Investor investing in equity shares of a company on behalf of his sub-accounts, the investment on behalf of each such sub-account shall not exceed ten percent of the total issued capital of that company. 10. The investment by the Foreign Institutional Investor shall also be subject to Government of India Guidelines. 11. A foreign Institutional Investor or sub-account may lend securities through an approved intermediary in accordance with the stock lending scheme of the Board.

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4. REASONS FOR THE ATTRACTIVENESS OF INDIAN ECONOMY

FOR FII
India gets more FII funds than Asian peers - The Hindu dated Nov 23, 2010 India had proved to be the most popular destination for overseas portfolio investors and stock holders to park their fund in the Asian region for 2010. It shows the increasing confidence in the Indian growth story, when the rest of the world is struggling to fight the recession. Bloomberg data shows that foreign institutional investors (FIIs) have purchased domestic equities worth $13.7 billion in 2010, making it the only Asian markets to have received more than $10 billion of investment this year. It is 56% higher than corresponding period of last year. This data is self sufficient to prove that India is one of the best destinations to park your funds. FII investment into India is over 57% higher than that of South Korean, which remains at the second slot in terms of overseas investment followed by Indonesia, Taiwan, Thailand, Philippines and Vietnam. But the question arises why India is so attractive in terms of FII when the manufacturing hub like China and the other Industry rich countries like Japan, South Korea are easily available. Following are the facts which make it the most attractive destination for the overseas investors to invest in the second fastest growing economy of the world: Draft direct tax code:- FII the key driver of Indian equity market had benefit a lot from the draft direct tax code to help India the attractive option to invest. The direct tax code would replace the Income Tax Act, 1961. The DDTC will help foreign investor to enjoying the so-called double-taxation avoidance benefit. Double tax treaties comprise of agreements between two countries, which, by eliminating international double taxation, promote exchange of goods, persons, services and investment of capital. These are bilateral economic agreements where the countries concerned evaluate the sacrifices and advantages which the treaty brings for each contracting state, including tax forgone and compensating economic advantages. A majority of FIIs are registered in tax havens such as Mauritius and Singapore. These countries have signed a double taxation avoidance agreement, or DTAA, with India and the entities registered there enjoy tax exemption. Hence India benefits to its overseas investor.

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Growth in GDP:- India is the 2nd fast growing economy after China and has been at the forefront of emerging out of the recession at a break through speed. The growth rate has jumped from 6.5 percent in 2009 to close to 9 percent this year. FII is increasing like never before due to this growth in GDP and it further adds to the sufficiency of capital in a country like India. Very high growth rates have the potential of creating around 10-15 million jobs across the country across sectors. Around 90% of these jobs would require skilled people at the forefront. This growth rate had shown India to be one of the most potensial destination in the form of safety of the money and the multiplication of money as the stock market is at its all time high and touching 20,000 mark. Friendly Government policies:- The government securities or G-sec are the most safe securities with almost zero defaulter for the share holder. In order to develop and boost long-term foreign investment, the government increased the investment limit for foreign institutional investors (FIIs) in government securities (G-Secs) and corporate bonds by $5 billion each. The cap in G-Secs and corporate bonds now stands at $10 billion and $20 billion, respectively previously it was $5 billion and $15 billion, hence making Indian market the most attractive for the FII. Political Stability:- Political conditions prevailing in a country also affect the stock prices. For a steady economic growth a stable and effective government is required. In absence of conducive political environment, the entire stock market is expected to take a hit but in case of India it is been lead by one of the best economist of the world Dr, Manmohan Singh, Present political scenario in India is very stable under UPA and hence also help to increase the credit rating of India and hence will directly improve the credit rating of companies doing business in India and hence attract more number of investor.

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5. EFFECT OF FII ON INDIAN MONETARY POLICY

The Indian Markets have been one of the most attractive investment places on the globe for the FII's. India being a developing nation attracts the foreign flows which are attracted by the growth potential in the Indian Economy. There has been a sharp elevation in daily inflows which has largely been attributed to the impressive IPO pipeline. It should also be noted that these FII inflows have a huge effect on the common man. The same foreign investors who bring large inflows to our country might flee with their profits when the times not right. This sharp reversal of funds flow might result in financial and economic instability. The large build- up of foreign exchange reserves through FII inflows poses a potential threat of destabilization of the economy. Portfolio flows are most often referred to as hot money that can be notoriously volatile when compared to other forms of capital flows. The Mexican crisis and the East Asian crisis are classic examples of the damage that sudden outflows of portfolio money can do to an economy. Thus, India also needs to focus on long-term flows in the form of foreign direct investment to sustain the economic reform process.

5.1.Appreciation of The Currency :

While other things remain constant, higher FII flows help in the appreciation of rupee. This allows Indian consumers to import foreign goods priced at a cheaper price. However, an appreciation in our currency also makes our exports uncompetitive in the global markets. As India is a developing economy, it would be beneficial to have a weaker currency which would improve exports and hence, generate higher domestic activity. Heres an example explaining the appreciation of rupee: The foreign exchange rate of our country is 1 USD = 50 INR but after some time the exchange rate fluctuate to 1 USD = 45 INR. This implies that the Indian rupees appreciated over the US dollar. The logic is indeed quite simple.

E.g. if Indian customer want buy one quantity of chocolate from USA market (here we suppose that price of 1 chocolate is 1 USD) he will have to pay 50 INR which is

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equal to 1 USD. But when exchange rate changes he will have to pay 45 INR instead of INR which is equal to 1 USD. In short purchasing power of Indian customer have rise now they will have to pay less amount to buy ice cream or they can buy more quantity of ice cream at same price . The fund inflows from Foreign Institutional Investors (FIIs), for the calendar year so far, have topped a record $24 billion and the rupee is up 4.4 percent. The net FII inflows touched a record USD 8 billion in September alone. It was the first time in this year that the central bank had to intervene and they bought dollars from the market in order to cool the rupee appreciation. When FIIs come in India they create rupees demand and by the very creation of this demand and supply rule the price of INR and it appreciates.

5.2.Depreciation of the Currency

This implies that if the rate is USD = 45 INR, but after some time the rate becomes 1 USD = 50 INR that means rupee has depreciated over the USD. For example: if India imports chocolate from USA then, earlier where they had to pay 45 INR now they have to pay 50INR for the same unit. Similarly if FII withdraws the capital from the domestic market or in other words if they sell their share it create the demand for US dollar hereby creating a higher demand for dollar and thus resulting in the depreciation of INR.

5.3.FII and exports:

There is an adverse effect on our economy as a result of appreciation of the Indian currency solely because of FII. Due to this net inflow in India, there is adverse effect on our export. Our export industry will become uncompetitive due to appreciation of rupees. E.g. if USD = INR 40 and a soap costs 1 USD. Now when the rupees appreciated 1 USD = 30 INR, the seller will have to sell the same soap to the US for 2 USD in order to sustain the same income that he has been making i.e. 40 INR.

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The logic is quite simple. First I sold my soap at INR which was equal to one USD. But after appreciation I would like to sell 2 USD to get my same income that means I will charge more US dollar from USA customer. Therefore, automatically with the increase in price, the demand decreases among the customers. The excess FII fund inflow in the country can also make a negative impact on the economy of the country. In this situation our Indian IT industries, jewelry and textiles industry affect. The Indian exporters are finding it extremely difficult to cope up with the wide and short term fluctuations in USD-INR exchange rate as they face heavy competition from the other competing countries along with the less favorable status for Indian Exports.

5.4.FII and stock market :

In case, when the cap on FII is high in that situation they can bring in lot of funds in countrys stock market. Thus they have great influence on the way the stock market behaves, determining whether it will go up or come down. The FII buying pushes the stock up and their selling shows the stock market down. FII has started playing a major role in movement of stock prices and have led to build a strong stock market infrastructure. There has been an increase in the activity of stock exchanges with the advent of on screen trading coupled with the clearance system which has lead to a new system known as the depository system.

5.5.FII and inflation

The huge amount of FII fund flow creates the huge demand for Indian rupees in which situation the RBI has to print more money in the market. This situation in turn leads to excess liquidity thereby leading to inflation , where too much money chase too few goods and service ( this is a perfect example of demand pull inflation)

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Thus there should be a limit to the FII inflow in the country which should be taken care by the government for the betterment of the common man.

5.6.FII and local companies :

With the advent of FII in any country, there is a huge availability of fund which is an opportune moment for the local companies to expand their coverage.

5.7.Capital formation in domestic market

In case when there is sufficient FII inflow, the country will not borrow from other countries or from international banks. With the FII flows being high, the demand-supply equation comes into the picture and the market tends to rise rapidly, in turn creating more wealth for the investor. This positive wealth effect often leads to higher consumption and greater demand for other asset classes such as gold, real-estate etc., which, in turn, fuels economic growth. Higher FII flows can, thus, be seen to help create wealth through higher asset prices. As India is developing country plus its domestic saving is low compared to the other developed countries therefore there is need for FII inflow.

5.8.FII and the Hot Money Concept :

Hot money refers to funds that are controlled by investors who actively seek shortterm returns. These investors scan the market for short-term, high interest rate investment opportunities. Hot money can have economic and financial repercussions on countries and banks. When money is injected into a country, the exchange rate for the country gaining the money strengthens, while the exchange rate for the country losing the money weakens. If money is withdrawn on short notice, the banking institution will experience a shortage of funds.

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We take an example: If RBI gives the interest rate 9% on foreign investor deposit which being quite high in Asia attracts foreign investor in Indian market in order to make capital gain. But simultaneously, if the Bank of China also raise their interest rate to 10 % which being the highest in Asia will attract all FII from Indian market to Chinese market. This will continue to happen if any nation again increases the interest rate. Thus, the FII inflows are very volatile. It has the capacity to disturb the economy at the time of coming and going. And hence this concept is called the hot money concept

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6. IMPACT OF FII ON THE FISCAL POLICY OF INDIA

The fiscal policy of any country revolves around the use of government expenditure and revenue generation from tax. To ensure that sufficient FIIs make increasing investments in our country the government of our country has been increasingly taking up a liberal approach in its fiscal policies. Amendments have been made on the Income Tax Act 1961 by levying just a 10% tax on the short term capital gains that the FIIs earn in the stock market. Double Taxation Avoidance Agreements (DTAA) are also becoming beneficial to the FIIs. The stimulus packages that have been injected into the economy for the purpose of reviving the economy post recession is a booster for increasing foreign institutional investments in the country. It has greatly helped in restoring trust and faith. FIIs have been a major driving force in the stock market post liberalization. They form a major part when it comes to achieving our economic goals. Recessionary trends had put most of the FIIs in the backseat but the conditions are improving now and they are largely responsible for us to achieve our fiscal targets. Government policies with regard to FIIs have been increasingly welcoming. A boost in the FIIs can be expected if our fiscal policies are able to reduce the amount of taxation made on the capital gains that the FIIs make in the stock market. But at the same time in India the influx of FIIs is increasing at a compounding rate. This has made the Central Bank start increasing its interest rates so as to suck the excess liquidity in the market.

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7. FIIS AND THE INDIAN STOCK MARKET

The FII investments in the countrys capital market have been steadily increasing since 1992. They show a significant impact on the movement of the stock market indices in India. It has shown increased influence on the domestic markets also The movement of the SENSEX is largely governed by the FIIs. They have a great impact on the market sentiments and price trends. Most market participants believe that FIIs have a foolproof judgment about the market scenario and hence resort to a herd mentality Data on trading activity of FIIs and domestic stock market turnover suggest that FIIs are becoming more important at the margin as an increasingly higher share of stock market turnover is accounted for by FII trading. Moreover, the findings of this study also indicate that Foreign Institutional Investors have emerged as the most dominant investor group in the domestic stock market in India. Particularly, in the companies that constitute the Bombay Stock Market Sensitivity Index (Sensex) and NSE Nifty, their level of control is very high. Dominant position of FIIs in the Sensex companies, it is not surprising that FIIs are in a position to influence the movement of Sensex and Nifty in a significant way. This dominance of FIIs in the market have made individual investors bank heavily on Mutual Funds. These mutual funds are now creating collaborations with foreign mutual funds and also adopting their kind of strategies. Unlike ordinary investors Mutual Funds are also capable of polarizing the market. Large share of FIIs in the equity capital of the company can put the firm in a precarious situation in case of a pull out. Hence the FIIs are a major factor affecting the financial health of the economy at large

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8. FOREIGN INVESTMENT FLOWS IN INDIA

One of the most important distinctions between Portfolio and Direct investment to have emerged from this young era of globalization is that portfolio investment can be much more volatile. TABLE: Foreign Investment Flows in India Year A. Direct Investment (US $ million) 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 97 129 315 586 1314 2144 2821 3557 2462 2155 4029 6131 4660 4675 B. Portfolio Investment (US $ million) 6 4 244 3567 3824 2748 3312 1828 61 3026 2760 2021 979 11377 Total (A + B) (US $ million) 103 133 559 4153 5138 4892 6133 5385 2523 5181 6789 8152 5639 16052

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From a net foreign investment inflow of US $ 5.3 billion in 1997-98, such inflows declined to US $ 2.4 billion in 1998-99. This is because of the lower portfolio inflows, as a result of which the net investment has dropped. The changes in the investment co nditions in a country or region can lead to dramatic swings in portfolio investment. For a country on the rise, in other words for developing countries, FPI can bring about rapid development, helping an emerging economy move quickly to take advantage of economic opportunity, creating many new jobs and significant wealth. However, when a country's economic situation takes a downturn, sometimes just by failing to meet the expectations of international investors, the large flow of money into a country can turn into a stampede away from it. CHART: FOREIGN INVESTMENT FLOWS
12000

10000 FOREIGN INVESTMENT INFLOWS

8000

6000

4000

2000

0
1990-91 1991-92 1992-93 1993-94 FPI FDI 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 YEAR

Foreign Portfolio Flows to India Foreign portfolio investments have been allowed in India on the basis of the recommendations of the Narasimham committee which stated: The committee would also suggest that the capital markets should be gradually opened up to foreign portfolio investments and simultaneously efforts should be initiated to improve the depth of the market by facilitating the issue of new types of equities and innovative debt instruments. (Narasimham committee report)
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Prior to 1992, only non-resident Indians (NRIs) and Overseas corporate bodies (OCBs) were allowed to undertake portfolio investment in India. Only on September 14, 1992 the Government of India issued guidelines on FII investments in India which was followed by a notification by Securities and Exchange Board of India (SEBI) three years later in November 1995.

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9. TRENDS IN FII INVESTMENT IN INDIA

TABLE: Trends in FII investment

Year

FII PURCHASE FII SALES in crores in crores 466 2835 2752 6979 12737 17699 46734 64116 41165 44371 99094

FII NET in crores 5126 4796 6942 8575 5958 -1584 10122 9934 8755 2689 45765

FII NET

CUM FII NET

US$ million US$ million 1634 1528 2036 2432 1649 -386 2339 2160 1846 562 9949 1638 3167 5202 7634 9284 8898 11237 13396 15242 15804 25754

1993-94 5593 1994-95 7631 1995-96 9694 1996-97 15554 1997-98 18695 1998-99 16115 1999-00 56856 2000-01 74051 2001-02 49920 2002-03 47060 2003-04 144858

Source: Reserve Bank of India Annual Report 2004 The investments by FIIs have been registering a steady growth since the opening of the Indian capital markets in September 1992. Their investments have always been net positive, but for 1998-99, when their sales were more than their purchases. It can be observed from the above table that the portfolio investment inflows have always been on the increase. But the years 2001-02 and 2002-03 saw some reversal in the trend. From a net inflow of US $ 2.1 billion in 2000-01, such inflows declined to US $ 1.8 billion in 2001-02, and further dropped to US $ 0.562 billion in 2002-03. The decline is

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because of the lower portfolio inflows, as a result of which the net investment has dropped in these years. However, this decline witnessed a sharp reversal in the year 200304. FIIs have made a net investment of Rs. 45,764 crores during this year registering a growth of 1602% over the previous year, creating a record in the history of FII investment in India. Gross purchases in this year amounted to Rs.144,857 crores, a growth rate of 208% compared to the year before. This trend continued in April 2004, only to suffer reversal again during May and June 2004, when the net investment became negative. Fortunately, the year from July 2004 has been seeing a net positive portfolio flows by FIIs. As of September 2004, the net FII portfolio investment stands at US $ 27,637 million. If it is so, then increasing the FII investment cap per se will not be helpful. The country has to work on specific measures to encourage more FII investments. The analysis of data indicates that there has been substantial divestment by the FIIs during the year 1998-99. The maximum outflow was during the months of May and June 1998 (almost US$430 millions). CHART : GROWTH OF FII INVESTMENTS IN INDIA

The trickle of FII flows to India that began in January 1993 has gradually expanded to an average monthly inflow of close to Rs. 1900 crores during the first six months of 2001. By June 2001, over 500 FIIs were registered with SEBI. The total amount of FII investment in India had accumulated to a formidable sum of over Rs.50,000 crores during this time. In terms of market capitalization too, the share of FIIs has steadily climbed to about 9% of the total market capitalization of BSE (which, in turn, accounts for over 90% of the total market capitalization in India).
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10. BIBLIOGRAPHY
www.mbaknol.com www.differencebetween.net www.theviewspaper.net www.coolavenues.com www.finance.mapsofworld.com www.finance.indiamart.com www.indiastudychannel.com SEBI Act., www.mbaknol.com www.wikipedia.com

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