Synopsis of End Term Projects On Title:.

Submitted By: Class & Roll No...

Proposed Supervisor.......... Area:..

(Signature of the Student)

(Signature of the Supervisor)

Lal Bahadur Shastri Institute of Management, Delhi

Plot No. 7, Sector 11, Dwarka, New Delhi 175001

Impact of Foreign Institutional Investment on Indian Stock Market

INTRODUCTION The era of foreign institutional investor (FIIs) in India originated in 1993 as a consequence of the major initiative towards globalization of economy by Government of India. For a country that embraced free market model after having remained closed to the outside world for long, foreign capital whether in the form of foreign direct investment or portfolio investment by FIIs is being considered imperative to rebuild India. Domestic markets are no longer able to meet the growing capital requirement of the industry and financing from the multinational institutions has lost its primacy in the emerging global order. Therefore, foreign capital is a sine qua non whether it comes in the form of direct investment or portfolio investment. Now the question arise that what is the meaning of the foreign direct investment and foreign institutional investors. Foreign direct investment means funds committed to a foreign enterprise. The investor may gain partial or total control of the enterprise. That can be done through joint ventures, technical collaborations and by taking part in management of a concern. On the other hand foreign institutional investment means investment in stock market by the institutional investors i.e. pension fund, mutual fund, trusts, assets management companies, portfolio managers etc. FII investment in domestic stock market has positive as well as negative aspects. On the positive side, FIIs, it is expected, could help to achieve a higher degree of liquidity at domestic market, increasing price-earning ratios and consequently reduce cost of capital for investment. They also lead to improvement in the functioning of the domestic stock market, as they are believed to invest on the basis of well-researched strategies and a realistic stock valuation. They also provide investors with an array of assets with varying degree of risk, return and liquidity. This increased choice of assets and existence of vibrant stock markets provides savers with more liquidity and options thereby augmenting household savings directed towards stock markets. By facilitating longer-term profitable investment, liquid markets can improve allocation of capital and can enhance prospects for long-term economic growth. On the negative side, they are best described as fair weather friends, which may cause market disruption. They are speculators whose investment are motivated by short-term gains. They pull back their investment at the slightest hint of trouble in the domestic country often leading to disastrous

consequences to its economy - a kind of making mountains out of a mole hole. They have also been held responsible for spreading financial crises causing contagion in international financial markets. Now coming back to India, following the recommendation of the Narsimham Committee report on Financial System, in September 1992 Government of India opened up countrys stock market to direct participation by FII. Since then Indian stock markets have experienced a steady growth both in numbers of FIIs registered and their volumes of investment. This is because Indian stock market is significant in terms of the degree of development, volume of trading and its tremendous growth potentials and moreover is expected to be more profitable then other stock markets in the region. FIIs operating in India comprise of pension funds, mutual funds, trusts, assets management companies, portfolio managers etc. Till today, more than 600 FIIs have registered with the market watchdog, Securities Exchange Board of India (SEBI). Some of the big names among them include Morgen Stanley, Templeton, Capital International, and Jardine Fleming etc. They can invest in all the securities including the equity and other securities listed or to be listed on the stock exchanges in India. They can also invest in Indian securities through the purchase of GDRs, FCCBs and FCBs issued by the Indian companies. Initially, FIIs were allowed to invest up to 24 percent of the paid up capital of a company. This ceiling was raised to 30 percent in 1997 and has been further raised to 40 percent in 2001. The market regulator SEBI to regulate the operations of FIIs in the country has also laid down all exhaustive regulatory frameworks. Let us take a view of the situation of FIIs investment in India. Foreign Institutional Investors (Rs. Crore)
2001 527 For Calendar Year 2002 2003 490 502 1,372 1,361 28,759 25,257 3,502 94,412 63,954 30,458 2004 637 1,785 1,85,672 1,46,707 38,965

End-Year number of FIIs End-year number of sub-accounts Spot market activity: Gross Buy Gross Sell Net

51,779 38,651 13,128

OBJECTIVES OF THE STUDY The broad objective of the study is to analyze the impact of foreign institutional investors investment on Indian stock market. The specific objectives of the study are as follows: To analyze the trend and process of FIIs investment in India. To examine the impact of FIIs investment on the Indian stock market in the terms of: i) ii) iii) Trading Volume Stock Return Volatility

To identify the determinants of the FIIs investment in emerging countries. To understand perception of FIIs and Indian institutional investors about the Indian stock market. To appraise the present legal and procedural aspects of FIIs investment. To comment about the role and impact of FIIs investment and procedural aspects to ensure stability of foreign inflows.

HYPOTHESIS The various assumptions to be tested are as follows: a) There is no change in the trade volume in Indian stock market by arriving the FIIs investment. b) There is no change in market volatility after the introduction of FIIs investment. c) There is no change in market return after the introduction of FIIs investment. d) The perception of Indian institutional investors and FIIs regarding the Indian stock market are same. REVIEW OF THE EARLIER STUDIES Academicians, professionals and journalists have already conducted research or written articles on the issues of FIIs and reviewed the trends in the growth, importance and impact of FIIs on Indian stock market. Some of the studies has reviewed here: Biswas, Joydeep (2005), conducted a study with an objective to study the role of FIIs in the development of noise driven Indian stock market. The inflows of huge institutional investments in India increased the turnover and market liquidity. But excessive speculation indulged by FIIs is the single most important reason for abnormal fluctuations of share price in Indian stock

market in the post-liberalization period. The study concludes that FIIs influence the share price movement in Indian stock market but their role in the development of Indian stock market is still questionable. Panda, Chkradhara (2005), tried to examine the impact of FIIs and mutual fund investments on Indian stock market by using Vector Autoregression (VAR) analysis and found that the returns on Indian stock market indices such as BSE Sensex and NSE Nifty were more affected by the mutual fund investment than FIIs investment. FIIs are found to follow positive feedback strategy and to have return chasing tendency. The study conclude that domestic investors like mutual funds in that case affect Indian stock market to a great extent than FIIs and recent boom in the Indian stock market could not be mainly because of large FII inflow. Singh, Sharwan Kumar (2004), in their study analyzed the policy towards foreign institutional investment, briefly highlights the nature of FII flows and explore some determinants of FII flows and examines if the overall experience had been stabilizing or destabilizing for the Indian capital market. The study concluded that the policies to FIIs investment in India had been substantially liberalized in the 1990s. the volatility of cross-border portfolios investment flows into India had been less than that in respect of other emerging market economies. It also concluded that FII flows were positively related with BSE Sensex. FII inflows to India display seasonality, with inflows being significantly higher in the first few months of the calendar year. Not withstanding their potentiality favorable impact on growth prospects, highly volatile nature of capital flows, especially portfolio flows and short term debt, underscores the need for efficient management of these flows. Batra (2003), using both daily and monthly data attempted to understand the trading behavior of FIIs and return in Indian equity Market. He found the strong evidence of FIIs chasing trends and adopting positive feedback and herding trading strategies. However, he did not find FII having any destabilizing impact on the equity market. Chakrabarti (2003), made an empirical investigation to see the interrelationship between FII flows and equity returns in India using monthly data. He came with the evidence that the FII flows are highly correlated with equity returns in India. He also found that FII flows are more

likely to be the effect than the cause of these returns, which contradicted the view that the FIIs determine market returns in general. Gorden and Gupta (2003), found that external factor (LIBOR rates and emerging stock market returns) and domestic factors (lagged stock market returns and changes in credit rating) were significantly factors in determining the foreign institutional investment flows in India. There was a strong element of the seasonality as the first quarter had a positive effect on flows related to anticipation of budget and reactions to the specific opportunities arising from it and past stock market returns had a negative effect on future flows. Pasricha, J.S. and Singh, Umesh C. (2001), has tried to find out the impact of FIIs on stock market volatility and found that FIIs have remained net investors in the country except during 1998-99 and their investment had been steadily growing since their entry in the Indian markets. They were here to stay and had become the integral part of Indian capital market. Although their investment in relation to market capitalization was quite low, they has emerged as market movers. The market had been moving, in consonance with their investment behavior. However, there entry had led to greater institutionalization of the market and their activities have provided depth to it. They had also contributed towards making Indian market modern and comparable with international standards. This had brought transparency in the market operations and simplified the procedure. S.S.S.Kumar (2000), studied regarding the stability of the foreign institutional investors in India and found that the volatility of Indian stock market before opening was 41.05 percent with a standard error of 5.05 percent where as the volatility after opening up is 22.66 percent with a standard deviation of 2.01 percent. The study also checked the significance of the difference in both by applying the F-test and inferred that volatility of the Indian stock market had reduced after the arrival of FIIs. Prasuna, C. Asha (2000), made an attempt to determine the determinants of the FIIs in India during post liberalization period by using the monthly data on net investments, movements in the month end Bombay Stock Exchange Index. The study tried to make preliminary attempts to

test to test whether the behavior of net investments by the FII can be studied with the help of associated macro economic variables of the recipients economy which influence these flows. Although a number of possible explanatory variables are included in the analysis, still nearly 50-55 percent of the variation could only be captured with these variables. The remaining 45 percent was still left unanswered. Inclusion of expected inflation, expected depreciation, political instability, policy variables and market capitalization etc. need to be tried to better explain the inflows and their determinants. The study determined that portfolios flows were primarily determined by the stock returns. Although the other economic variables influence the inflows their impact was found to be insignificant. Rao, Chalapati (1999), analyzed the investment exposure of five US based India specific funds, which suggested a close resemblance between FII investment profile and trading pattern at the BSE. However, they did not study the causality between FII flows and BSE

RESEARCH METHODOLOGY Research methodology comprises the following: a) Database The data is likely to be collected using secondary sources. The data relating to foreign institutional investment will be collected from the NSE and BSE website as well as from the published sources such as various journals, Govt. reports, newspapers etc. b) Research Tools Research tools deals with the econometric techniques to measure the volatility, liquidity & marketability. To measure the volatility, the GARCH class of Models would be used. GARCH model has been developed by Bollerslev (1986) from the Autoregressive Conditional Hetroscedasticity (ARCH) model previously introduced by Engle (1982). GARCH framework is very widely used in financial literature due to in ability to capture volatility clustering especially when the data is large and hetroscedastic in nature. Other statistical tools would be used as per the requirement of the study. To determine the perception of foreign institutional investors and Indian institutional investors a primary survey will be conducted by using the questionnaire method. c) Study period

The scope of the study is limited to assess the impact of Foreign institutional investment on BSE Sensex. Therefore, the weekly investment for the period Jan. 1995 to June 2005 will be used. SIGNIFICANCE OF THE STUDY As we know that the BSE Sensex in these days is at boom and crossed the highest point of 8000. That is mainly due to foreign institutional investment. Our finance Minister P. Chidambram stated that, this boom is not harmful for our economy and not supposed to decline in near future. Now the question arise that why it is so? Why the foreign institutional investors coming to India? What will be impact of this boom on Indian stock market? To find out the answer of these questions and to know another aspects related to foreign institutional investment the study is structured. As it is clear from the above discussion a lot of studies have been carried on the topic of foreign institutional investment in India. But these studies are suffering from some limitations such as short time period, use of traditional tools etc. The present study is an attempt to find out the impact of foreign institutional investment on Indian stock market and to highlight the procedural and legal aspect related to foreign institutional investment in India. The study will also contain the trends of foreign institutional investment in India and with the help of the data an attempt will be made to determine the factors determining the flow of FIIs in India. The study will try to conduct a primary survey over FIIs to know their perception regarding Indian stock market and a comparison will also conduct to find out the difference between the behavior of FIIs and Indian institutional investors.

ORGANISATION OF THE STUDY The proposed chapterisation scheme is as follows: 1. 2. 3. 4. 5. Introduction to Foreign Intuitional Investment Review of Literature Objectives and Research Methodology Impact of FIIs on stock market. Finding & Policy Implications

BIBLIOGRAPHY Batra, A., The Dynamic of Foreign Portfolio Inflows and Equity Returns in India, Working Paper, ICRIER, New Delhi, October 2003. Bhalla, V.K., Investment Management, S.Chand Publications, New Delhi, 2005. Biswas, Joydeep, Foreign Portfolios Investment and Stock Market Behavior in a Liberalized Economy: An Indian Experience, Asian Economic Review, August 2005, Vol. 47, No.2, pp. 221-232. Chakrabarti, Rajesh, FII Flows to India: Nature and Causes, Journal of Finance, 2003. Gorden, J. and Gupta, P., Portfolio Flows into India: Do Domestic Fundamentals Matter?, IMF Working Paper No. 20, International Monetary Fund, 2003. Gopinath, T., Foreign Investment in India: Policy Issues, Trends, and Prospects, RBI Occasional Papers, June 1997. Gupta, Arindam, Toward global Stock Exchange, Indian Journal of Accounting, December 1999, pp. 19-29. Gujarati D.N. (1995): Basic Econometric, Tata Mcgraw Hill Publications Khan MY (2000):Indian Financial System, Tata Mcgraw Hill. Machiraju, Indian Financial System, Vikas Publishing Company, New Delhi, 2001. Narsimhan M., Globalization of Financial Markets in India, ASCI Journal of Management, Vol. 19, No.1, 1989, pp 1-15. Patnaik, Umesh C., Globalization and Foreign investment in India, The Indian Journal of Commerce, December 1993, pp. 20-24. Pasricha, J.S. and Singh, Umesh C., Foreign Institutional Investors and Stock Market Volatility, The Indian Journal of Commerce, Vol. No. 54, No.3, July-September 2001, pp. 29-35. Panda Chakradhara, An Empirical Analysis of the Impact of FIIs Investment on Indian Stock Market, Applied Finance, January 2005, pp 53-61. Phatak Bhatri V (2003):Indian Financial System,Pearson Education. Prasuna, C. Asha, Determinants of Foreign Institutional Investment in India, Finance India, January 2000, pp 411-421.

Rao, K.S., Murthy, M.R. and Ranaganathan, K.V.K., Foreign Institutional Investment and the Indian Stock Market, Journal of Indian School of Political Economy, Vol. 11 (4), pp.623-647.

Singh, Sharwan Kumar, Foreign Portfolio Investment, The Indian Journal of Commerce, Vol.57, No.4, October-December 2004, pp. 120-137. S.S.S.Kumar, Foreign Institutional Investment: Stabilizing or Destabilizing?, Abhigyan, 2000, pp. 23-27.

Signature of Supervisor

Signature of Student