Impact of foreign institutional investors on Indian stock market
|✅ Paper Type: Free Essay||✅ Subject: Business|
|✅ Wordcount: 5408 words||✅ Published: 1st Jan 2015|
Generalities of Study
In the initial period the economic growth of all the countries were started by government planning and action by developing the agricultural, manufacturing and the infrastructure facilities of the country. Though these facilities were adequate for the economy but it didn’t boost the domestic growth of the country as it did not lead to much saving or any further investment. Since these domestic savings were inadequate, countries had to depend on the loans from different countries for the development of their country through different public organisations. This led to growth of economies by increased foreign investments which came in the form of overseas loans. Foreign capital plays a significant role in the development of any economy. It fills the gap between domestic savings and its required investment for growth. But this investment limited the scope of growth as loans were not easily available. So countries induced foreign investments by allowing them to invest in the companies listed on stock markets to a major extent. This led to development of stock markets.
If you need assistance with writing your essay, our professional essay writing service is here to help!Essay Writing Service
Stock Markets initially were just a way for people to invest their money into different companies and they were not that big. But as of today they have become an important part in the growth process of any country. Due to development of stock markets, economies are getting globalised and world is getting smaller. Hence the significance of stock markets has grown above leaps and bounds. As of today the Gross Domestic Production of a country largely depends on stock markets. As a result each country is trying to enhance its stock markets in order to attract foreign investments and to boost the growth process of their own country.
The best decision of the century has been the financial liberalisation of the equity markets all over the world which gave opportunity for foreign investors to invest in domestic markets especially of the emerging economies. According to Lalitha, S (1992), the main reason for opening stock market for FIIs was to attract foreign investments and stop country from raising more debts. According to Cerny (2004), the behaviour of stock market is affected by the globalisation of the world economy.
The Foreign Investors are eyeing these days on the Asian markets specially India due to many obvious reasons. First of all growth potential in Asian Markets is higher, secondly its cheaper in countries like India to invest as the costs are low, thirdly there is a higher investor base and fourthly mostly the Asian economies are developing and hence the Governments are welcoming to Foreign investors as they play a major role in boosting the growth of the country.
Now the question that arises is who are Foreign Institutional Investors? According to SEBI, FII means an entity which is established or incorporated outside India and which proposes to make investments in India. According to Sehgal and Tripathi (2009) FIIs are speculators instead of investors as they tend to invest in stock for short term and after attaining short term gains they tend to move away to different company and this might lead to volatility in stock prices and may lead to financial crisis. FIIs investments in stock market increases volatility in market due to excessive liquidity but it also leads improvement in value of stocks.
According to Choe et al., (1999) & Froot et al., (2001) & Griffins et al., (2002), Foreign Investors run after returns from stocks, in a way they will buy shares in those companies whose returns they expect to be high. According to Syste et al. (2003), Foreign Investors invest in large liquid companies which enable them to exit quickly at lower cost. Another research by Prasana (2008) Foreign Institutional Investors have been eyeing on Indian Markets because of the positive fundamentals of the economy and potential to grow fast. Since foreign investors are freely available and are unpredictable, therefore FIIs are always on look out for profit. FIIs move their investments regularly and because of these swings there is a tendency to be fluctuations in prices and hence increased volatility in the market. Another study by Clark and Berko (1997) finds that stock prices rises due to increase in capital flows by foreign institutional investors but they could not conclude that the rise in prices are for short term or for long term. Another finding which indicates positivity of presence of FIIs was produced by Banaji (2000). According to him, due to presence of FIIs in Indian market there has been improved transparency in the procedures, automation and regulations regarding disclosure and reporting standards were initiated. So it becomes the necessity to study the Impact Foreign Institutional Investors have on Indian Stock Market.
Background of Indian Economy
India was ruled for nearly 200 years by British rule and in 1947 it gained its independence.( http://www.iloveindia.com/history/modern-history/british-india.html) So the growth of India has come in the last 60 years in which Indian economy has been thriving to set its foothold in the world. Under the British rule India was mainly dependent on its agricultural production and few basic industries were in existence as in textile industry which was basically for the benefit of the British colony to support them in their trade for European goods by exporting Indian basic agricultural goods and textile manufactures.
After Independence, India carried on with its policy of attaining self sufficiency and closed the doors for the foreign investors. But this policy of government limited the growth of economy. So in order to finance the needs to economy of providing basic necessities to its citizen’s and for getting over with the burden of loans as the foreign reserves were at their all time low, Government of India took support from World Bank and International Monetary Fund to get the country on to revival path. These organisations agreed to help Indian economy on the condition that they will allow foreign investors to enter India.
So basically a reform process was initiated in India after balance of payment crisis of 1991 which was recommended by M. Narsimham, chairman of committee of financial system. This became starting point of deregulation of financial sector and development of various sectors of financial markets. This resulted in significant changes in Indian market from dull to highly buoyant stock market. As a result Indian markets were opened to foreign institutional investors in September 1992 and this event led to effective globalising of the financial services and since then the Foreign Institutional Investments have been rising positively year on year. These investments helped India in developing infrastructural facilities which were necessary for the growth of the country. These investments were led due to increasing confidence in Indian stock markets which were based on strong macro-economic fundamentals of the economy, abolition of long term capital gain tax, improved performance of Indian companies and transparency in the regulatory system.
The opening up of markets for foreign investors had its own pros and cons. Pros of financial liberalisation are that firstly stock markets had to improve its trading mechanism and match up to world standards and secondly with the presence of foreign investors, information system saw a drastic change. Con of financial liberalisation was that it brought destabilisation in the economy and increased more volatility in stock movements. But overall it increased confidence of foreign investors in Indian stock market. The last two decades has led to growing participation of Institutional Investors which includes not only the foreign Institutional investments but also investments by domestic institutional investors.
Indian economy has been an attractive avenue for foreign investors as nearly 16% of the world population lives in India and also India has joined the elite club of 12 countries to cross trillion dollar economy. Other countries which have in past breached this trillion dollar economy mark in the past includes countries like U.S, Japan, Germany, China, France, U.K, Italy, Spain, Canada, Brazil and Russia. Besides this country’s stock Market capitalisation has also risen to $944 billion which is close to trillion dollar level. As per Credit Suisse Report, stock markets have risen in eight out of ten countries after reaching this mark.
Foreign Institutions have played a major role in Foreign Investments in India which resulted in changing the face of Indian Stock Market. According to M Puri, ICICI Securities Chief, ( 2009) India has been looked upon as the safest destination for foreign investors. Foreign Institutional Investors are the companies which are registered outside India. They are registered with Securities and Exchange Board of India and they are guided by SEBI in participating in stock market through limits placed by it. The major source of their investment in Indian Stock market is through Participatory notes which are almost 50% of the money invested in markets. The disadvantage of participatory notes is that the investor is anonymous and hence it could be an investment by any organisation including terrorist organisations. Foreign Institutional Investors have invested more than $41trillion of funds in India in the past four years which resulted in bull market witnessing unprecedented growth with BSE Sensex rising in absolute terms. India has witnessed over a decade of FIIs portfolio flows and these flows have gained significance and have played a key role in the overall Indian Economy.
The impact of foreign investments in India is significant. The increasing role of Institutional investors led to both qualitative and quantitative developments in Indian Stock Markets. The Foreign institutional investors has also impacted the domestic investors to a large extent in the sense that if FIIs sell the stocks then there is a situation of panic created among the domestic investors and they tend to sell as well. Hence there is a need to study its impact on Indian companies and economy in general taking into consideration all the factors affecting movement of stocks on Indian Stock Market.
Significance of Study
Indian economy is growing at a very fast pace. Most of the FIIs are investing in India due to its significant growth. These FIIs though they are investing in the country, they not only invest for profit they also are affecting the movement of stocks in stock markets. Hence they are impacting the stock market in a large way which is an important perimeter of the Indian economy as it contributes to the growth process of Indian Economy. So it is significant to study the impact of Foreign Institutional Investments on Indian Stock Market.
Objectives of Study
The main objectives of study are:
- To analyse the impact of FIIs investments on the shareholding pattern of Stock exchange companies.
- To find way to reduce risk associated with investing in stock market and to know when to exit.
- To look for investment opportunities
Review of Literature and Studies
Determinants of FIIs
Foreign Institutional Investors play a major role in the economic growth of India. Their impact is significant even though their market capitalisation is not much and is improving year on year. Several attempts have been made to understand the impact FIIs have on Indian Stock markets. According to Aggarwal 1997, Chakrabarti 2001 and Trivedi and Nair 2003(cited in Rai and Bhanumurthy) equity returns have positive impact on FIIs. But Gordon and Gupta,2003 ( as citied in Rai and Bhanumurthy) contradict by saying that foreign investors are here for earning profits, they invest in a company and make the price go up as other investors follow and then book their profits and leave. So it can be said that there is a bidirectional relationship between FIIs and equity return.
After the bursting of infotech bubble in 1998 and Asian crisis, Chakrabarti (2001) analysed and found a shift in regime in the determinants of FIIs. He analysed that before the Asian crisis, any change in investment pattern by FIIs had a positive impact on equity returns but after Asian Crisis he found that if there is a change in equity return then the behaviour of FIIs change. But Trivedi and Nair (2003) are of a different view point, they feel that any investments made depend a lot on the risk associated with it. They further divide realised risk into two factors, ex-ante and unexpected risk. According to them, ex-ante risk is negatively related to FIIs whereas the relation of FII with unexpected risk is not certain. This is because uncertain activities can bring unimaginable loss or gain depending on the situation. Take for example U.S subprime crisis. Those crises were unexpected and they led to unexpected movement in stock markets and FIIs activity.
Studies in the past have concluded that the return in source country and inflation in that country doesn’t exert pressure on FII. But this theory has been contradicted by the recent subprime recession in US which led to most of FIIs withdrawing their investments in order to cope up with crisis in their own country. Hence if stock markets of foreign investor’s home country are doing well and there is stability in their economy then it leads to a positive impact on the investments by FIIs.
According to Aggarwal 1997 (as cited in Rai and Bhanumurthy 2004) world stock market capitalisation has a positive impact on growth of FIIs in India. According to literature survey shows that most of the existing studies do not reflect the effect of stock volatility and also they do not account for realised risks in foreign and domestic markets.
Another observation by Ahmadjian and Robbins (2005) after analysing firms in Japanese economy showed that foreign investors are more inclined towards profit making than going in for long term ownership. They tend to make money and move away towards other company.
Investment Preferences of FIIs
According to Douma, Pallathiatta and Kabir (2006) there is a positive impact of foreign ownership on firm performance and especially on the emerging economies. They also found the impact on business group affiliations of FIIs But FIIs don’t invest in any firm, they invest in those firms which have good corporate governance as the firms with poor corporate governance are least protective about the investors and instead they are concerned about their own interest only, this was observed by Aggarwal, Klapper and Wysocki (2005). According to them companies which are controlled by block of shareholders they find it difficult to find external investors as they are derived by private benefits and may manipulate things accordingly. This was already concluded by Cho and Padmanabhan 2001 (as cited in Prasana 2008) that block shareholders influence firm performance. They also said that corporate governance of listed companies play an important role in attracting foreign investments. They also clarified that block shareholders mean basically businesses run by family groups and distinguished them from times when government acts as block shareholders; they act quiet differently from private investors. Bhanumurthy and Rai (2003) made an attempt to examine the determinants of FIIs by using the monthly data from January 1994- November 2002 by analyzing the effect of return, risk and inflation in domestic and foreign economy. They firstly calculate the domestic and foreign returns from daily returns on BSE Sensex and S&P 500. After the analyses they find out that FIIs inflow depend on stock market returns, inflation rate and Ex-ante risk.
According to Yin-Hua and Woidtke 2005 (cited in Prasana 2008) investor’s protection is weak when company board is dominated by members of controlling family and it gets difficult to separate the ownership from management then firm value is inversely related to family ownership firms. Their view was supported by Choe, Kho, Stulz (2005) who analysed US investors and concluded that they hold fewer shares in companies where ownership structure is more conducive to insiders. Another observation by LI (2005) was that if there was poor corporate governance then foreign investors tend to prefer other route of Foreign Direct Investment instead as Foreign Institutional Investors. Going further in accessing the information on firm ownership, Leuz, Nanda and Wyoscki (2003) assessed the firm level characteristics and found family control increases insider trading which gives less benefit to foreign investors. They were supported by Haw, Hu, Hwang and Wu (2004) who concluded that firm level characteristics cause information asymmetry problems for FIIs.
In order to analyse the investment preferences of FIIs, Dahlquist et al (2003) analysed the foreign ownership and firm characteristics of Swedish Stock Market and they concluded that FIIs prefer firms which are large, pay low dividends and have a huge cash holdings. Whereas Covirg et al (2007) were of the view that foreign managers have comparatively less information than domestic managers and hence they concern FIIs preference to be based on size of sales and stocks which are listed on foreign soil.
According to Li and Jeong-Bon 2004 (as cited in Prasana 2008), FIIs are in a better position to analyse the public information and hence they tend to avoid stocks with high cross-corporate holdings whereas according to Morin 2000 (as cited in Prasana 2008) as they analysed the French model of shareholding and management of FII pattern concluded that France has undergone a rapid change and has gone away with the traditional system of FII holding and facilitated with new techniques which demands corporate management.
Stock Market Volatility
Research by Forbes and Rigobon (2002), Bekaert, Harvey and Lumsdaine (2002a,b) , Edwards (2000) and others focussed on stock market volatility concentrating on moving of volatilities among different economies and also of the financial crisis which happened thereafter. Bakaert and Harvey 2000 (as cited in Batra 2004) analysed equity returns of a group of emerging markets before and after financial reforms. According to Aggarwal, Inclan and Leal 1999 (as cited in Batra 2004) local events and happenings make the stock markets to turn volatile in emerging economies. In order to draw this conclusion they analysed emerging stock markets for volatility for period of 1985-95 and by using ICSS algorithm they identified points of sudden change when some event occurred or when there was large movement in stock market volatility. They calculated the variance at each point. According to De Santis and Imrohoroglu 1997 (cited in Ranjan Kumar Dash and Sumanjeet Singh) studied the behaviour of volatility in emerging markets and the effect of liberalisation on financial markets and concluded that volatility decreased after liberalisation. Their study was contradicted by Singh (1993), Grabel (1995), Levine and Zervous (1998), Kamminsky and Schmickler (2001 and 2003), Nission (2002) and Edwards et al. 2003 (cited in Ranjan Kumar Dash and Sumanjeet Singh) by saying that financial liberalisation increases stock market volatility. In Indian context, Samal 1997 and Pal 1998 (cited in Ranjan Kumar Dash and Sumanjeet Singh) found that FIIs investment is the major source of volatility whereas stock market volatility was lower in liberalized economy. This view was supported by Richards 1996 who took three different methodologies and two different sets of data to calculate the volatility in emerging markets and came with the conclusion that there was no empirical evidence which supports that liberalization of economy increases volatility in stock markets.
Our academic experts are ready and waiting to assist with any writing project you may have. From simple essay plans, through to full dissertations, you can guarantee we have a service perfectly matched to your needs.View our services
Hamao and Mei 2001(as cited in Batra 2004) examined Japanese market at a time when foreign portfolio investments in Japan were small and found no proper evidence to prove that foreign investments tend to increase volatility more than increase in volatility due to domestic investors. Folkerts – Landau and Ito 1995 (as cited in Batra 2004) computed market volatility in emerging economies at different periods in which there was a difference in flow of portfolio and found in case of Mexico that stock prices were less volatile when Foreign flows were more volatile and vice versa for Hong Kong. According to Nilsson (2002) by using Markov regime switching model in Nordic Stock markets, liberalisation in stock markets leads to increase in volatility. Nilsson also evidenced that higher volatility and higher expected returns have strong links with international stock markets.
Considerable attention has been paid these days to stock market volatility and especially after global recession. Stock Markets had been highly volatile in emerging markets like India and its study becomes important.
Investment strategies of FIIs
There has been a considerable amount of research done on the investment strategies of FIIs which show the Positive feedback and herding strategies being followed by FIIs. Research done by Lakonishok, Shleifer and Vishny (LSV) 1992(cited in Sehgal and Tripathi 2009) looked at the investment behaviour of 769 US tax exempt equity funds managed by 341 money managers for the period of 1985 to 1989. They concluded that there was no herding by money managers but it was prevailing in the behaviour of stock prices of small companies than in large companies. The reason given by LSV is that information on large stocks is easily available whereas small companies do not provide much information to public, so money managers look at the investments by other big investors into small stock and follow them. According to LSV, it is difficult to find the effect of herding as at times a small amount of herding can bring significant movement in stock prices. An argument was put forward by Dornbusch and Park (1995) that foreign investors follow positive feedback strategy which leads to stock unusual movement in stock prices.
Wermers 1998 (cited in Sehgal and Tripathi 2009) used LSV measures to check the presence of herding among mutual funds. He took the quarterly data of mutual funds from 1975 till 1994 and concluded that mutual funds showed existence of herding. He also analysed stocks and concluded that herding among those stocks tend to be higher which had reported higher amounts stock returns in the previous quarter. He concluded that investors buy those stocks which had good returns in the previous quarter and sell those stocks which had poor quarterly results. After computing average level of herding by Wermers model it was concluded that herding is more in mutual funds than in stocks. But after analysis of trading behaviour of large pool of mutual funds it was found that the herding behaviour in fact reduces in mutual funds and it was justified as large pool of mutual funds carry stock which have large amount of capitalisation and companies with large capitalisation tend not to do any herding. Another analysis by Bonser- Neal et al 2002 (cited in Sehgal and Tripathi 2009) analysed the foreign trading behaviour on Jakarta Stock exchange between 1995 and 2000 and found positive feedback trading and herding by foreign investors but they didn’t find any evidence indicating destabilising of markets due to foreign investors during Asian crisis. Richards 2002 (cited in Sehgal and Tripathi 2009) used data pertaining to net purchases by foreign investors in six Asian emerging markets over 1999-2001 and found an evidence of positive feedback trading.
According to Kim and Wei (2002) foreign investors who live outside Korea are more likely to indulge in positive feedback trading and herding strategies as compared to their branches and subsidiaries who are living in Korea or any foreign national staying in Korea. According to them this difference in trading behaviour arises due to different kind of processing of information by those living outside Korea than those living inside.
Data and Methodology
Research Methodology and Design
According to Collis and Hussey (2003), Methodology refers to overall approach to research process which includes underpinning of theory, collection of data and analysing it. However the research process adopted depends to a great extent on the approach taken by the researcher. Research design is the general plan of how to go about answering the research question. It gives the logic behind every interpretation. Due to nature of research carried out the prime focus has been on gathering the secondary data which is relevant to analysis being carried out. According to Collis and Hussey (2003), there are two main paradigms of research that is qualitative and quantitative. Qualitative research is followed by those people who have phenomenological bent as it deals with understanding the behaviour of human beings. Therefore it is also known as Phenomenological Paradigm. On the other hand Quantitative research refers to those who relate to positive view of the world and therefore this kind of research is also called as Positivistic Paradigm. Positivistic paradigm is used basically in natural sciences as this approach gathers facts with subjectivity of the nature of research and individual bias.
For the purpose of research both qualitative and quantitative data will form part.
Qualitative Data: this data has been collected by:
- Studying into the certain days on which markets fluctuated in upside or downside direction to a great extent
- Studying the changes in regulations by the Securities and Exchange Board of India in relation to foreign institutional investors.
- Studying the behavior of domestic investors and other factors affecting the market.
- Studying the basis on which the foreign institutional investors entered Indian Stock Market and there enter and exit strategy and its impact on Indian economy.
Quantitative Data: this data has been collected by:
- Studying the market capitalization of foreign institutional investors and their cumulative effect on stock market
- Looking in the growth of number of institutional investors and the share of their investments year on year.
The research onion below in the diagram gives an overview, how to achieve the objectives by using the techniques in each layer of the onion.
In order to carry on with the research each onion of the Research Onion has been peeled systematically so as to get in the right direction. The philosophy adopted for the purpose of research is Positivism philosophy as research has been undertaken mostly from the data already published in journals, articles, previous researches etc. Approach taken by the researcher is mainly inductive as maximum data is qualitative and it has been of utmost importance to cover every aspect of research. Researcher has taken the case study strategy to analyse the data. The Researcher has used Mixed Method research choice in the sense the data collected comprises of both qualitative and quantitative data. The time horizon for research has been longitudinal as this research has been carried on after observing the behaviour of stock markets over a long period of time and on happening of any event.
While carrying out the research it has been kept in mind that the research objectives and the characteristics of the information collected match. In order to analyse the Impact of FIIs on Indian Stock market, a thorough research has been done from different sources which includes RBI and SEBI publications, newspaper articles, journals, previous research done on the topic and also from internet.
For the purpose of our research study we are looking into the data till financial year 2008-09.
Limitations of Study:
This study has been taken during the time when impact of recession has not been fully analysed and its exact nature and impact on the movement of stock markets and Financial Institutional Investors cannot be justified as it is a global recession. So research may miss out some of the implications of recession and may not correlate to impact which FIIs may have during the normal market conditions.
Data has been collected mostly through online source. It was not possible to conduct personnel interviews with top brokers in India due to distance barriers. Hence the findings and analysis has been derived on the basis of data available online.
Summary of Research:
The majority of this research is conducted by making use of secondary sources of data which includes journals, articles, books, magazines, newspapers, Internet and other electronic sources. The research in this area has already been conducted but the purpose of this research is to generate new ideas and to gain further understanding into the subject by looking into each and every detail of it. This research is conducted at the time of recession, the condition which was not prevalent earlier, so it is expected to bring new concepts and theories into existent and it will also over rule some of the studies that have already been conducted.
Analysis of Indian Stock Market
Overview of Indian Stock Market
Stock markets were first introduced to India in 1875 as a non profit making organisation. Bombay Stock exchange is the oldest stock market in whole Asia. Stocks in India are traded on the stock exchanges which are around 23 which includes Bombay Stock Exchange and National Stock Exchange. Stock exchange is a corporation which provides its brokers to trade stocks of companies which are listed with them. The organisation of Stock Exchange, its systems and practices are regulated by Securities Contract, (Regulation) Act (SC(R) ACT), 1956.They are highly efficient organisations which have led to growth of securities market. Stock exchanges trade securities which include shares, unit trust, pooled investments and also bonds which are listed on them. Members of the stock exchange act as its agents as they are only allowed to trade on behalf of their customers who pay brokerage to them for the services provided by them. Stock exchanges also provide plenty of services as in issuing and redeeming shares and also in payment of dividends to its shareholders through its participants or members.
Stock exchanges are important even though it is not necessary to issue shares via stock exchange. Shares are normally issued through Initial Public Offering (IPO). Stock exchanges play a major role in the economy as of today as they help with expansion plans of the country by mobilising the savings to investments and also by redistributing wealth among the economy.
Stock exchanges maintains the records of all the shareholders at one central location but shares that are traded on stock exchange they are not dependent on that central location as the computerisation has made it easier to trade stocks. All stock exchanges have become an important part of world market for securities as global investors can invest in any market from anywhere.
Importance of Stock Markets in India:
Stock markets play an important role in the economy as they are now the financial indicators of growth in any country. They represent the crux of functioning of all the sectors of country. NSE NIFTY comprises of 50 top Indian companies from each sector and BSE SENSEX comprises of 30 companies from all the sectors. The following points describe the role stock markets play in India:
- Improving Corporate Governance: Since Stock markets are regulated by SEBI, companies are bound to follow the rules and regulations in order to have a good market value of their stocks on stock markets. This is possible only if they keep their shareholders satisfied. So they
Cite This Work
To export a reference to this article please select a referencing stye below:
Related ServicesView all
DMCA / Removal Request
If you are the original writer of this essay and no longer wish to have your work published on UKEssays.com then please: