What is the impact of FIIs on Indian National stock exchange and to study how effective is government role in liberalizing and controlling the National stock exchange?

ABSTRACT

The intention of this research was to examine the impact of Foreign Institutional Investors (FII) on Indian National Stock Exchange (NSE). To achieve the aims following objectives has been determined as to study how FII plays an important role in National stock exchange; to study the working mechanism of National stock exchange; to critically analyze the impact of shareholders on the share market; to identify the success and failure factors of FII on Indian economy and to critically analyse various rules set by government for FII participation in Indian stock exchange.

In this research both secondary (books, magazine, journals and articles) and primary data were collected considering the nature of required information. For primary data, questionnaire survey conducted and only structured questions were designed for the survey (questions with multiple options). The questionnaire consisted of 10 structured questions.

The key results of the research are as following: FII has a positive influence on the volatility of the exchange rate, meaning that foreign investment’s inward remittances may increase volatility in exchange rate, however, presence of a foreign venture capital investor and indirect ties to foreign venture capitals through syndication networks of own domestic investors help mitigate the problems. Based on this finding, it was tested in this research as how often do you find that foreign FIIs have restricted the investors in India to have access in stock market. The first hand data collected in the research confirms that in most cases, foreign FIIs have restricted the investors in India to have access in stock market. Furthermore, there is a regime shift in the determinants of FII following the Asian financial crisis and found that in the pre–Asian crisis period, any change in FII had a positive impact on equity returns, where realized risk can be divided into ex-ante and unexpected risk and ex-ante risk is an observed component and is negatively related to FII. But the relationship between unexpected risk and FII is obscure. Based on this findings, it was tested in this research as how effective is regulatory system in India to deal with FII risk in stock market. The first hand data collected in the research confirms that regulatory system in India is generally not effective to deal with foreign FIIs risk in Indian stock market.

Chapter 1- INTRODUCTION

1.1 BACKGROUND INFORMATION AND RATIONALE

Fear of capital flows is, partially, entrenched in their impenetrability. The route of exclusion of capital controls in India is leading to a upsurge of empirical experience with financial globalisation. A test of data in relation to FII inflows into India yields mesmerizing explanations at the level of both macroeconomics and firm characteristics. FIIs have convertibility on the equity market, and this is the most vital solo element of India's de jure openness. It is, therefore, important to study FII flows. During March 2001 and March 2007, the market value of shares owned by FIIs went up from $9.7 billion to $124 billion (Business Standard, 2008).

Specified the existence of FIIs in Sensex companies and their lively trading behaviours, their part in determining share price movements ought to be considerable. Indian stock markets are identified to be narrow and trivial in the wisdom that there are few companies whose shares are vigorously traded. Therefore, even though there are more than 4,700 companies listed on the stock exchange, the BSE Sensex incorporates just 30 companies, trading in whose shares is observed as indicative of market activity (Chandrasekhar and Ghosh, 2005). This triviality would also signify that the effects of FII activity would be exaggerated by the influence their behaviour has on other retail investors, who, in herd-like fashion be apt to track the FIIs when making their investment decisions.

These characteristics of Indian stock markets persuade a high degree of volatility for four reasons (Chandrasekhar and Ghosh, 2005). Firstly, an increase in investment by FIIs sets off a sharp price increase, it would offer added incentives for FII investment and in the first occurrence encourage further purchases, so that there is a propensity for any correction of price increases gratuitous by price earnings ratios to be delayed. As well as while the correction begins it would have to be led by an FII supplement and can take the form of a tremendously sharp decline in prices. Secondly, as and when FIIs are attracted to the market by expectations of a price augment that be apt to be robotically realised, the inflow of foreign capital can result in an appreciation of the rupee vis-à-vis the dollar. This increases the return earned in foreign exchange, when rupee assets are sold and the revenue converted into dollars. Consequently, the investments turn even more attractive setting off an investment spiral that would entail a sharper fall while any correction begins. Thirdly, the increasing realisation by the FIIs of the power they exert in what are trivial markets, encourages tentative investment aimed at pushing the market up and deciding a fitting moment to exit. This implied handling of the market if resorted to often enough would clearly entail a considerable increase in volatility. Lastly, in volatile markets, domestic speculators as well go to control markets in periods of strangely high prices. Therefore, the volatility being displayed by India's equity markets merit returning to a set of questions that have been avoided in through neo-liberal reform in India. The most vital of those questions is whether India requires FII investment at all.

Optimistic feedback trading, where FIIs obtain more stocks on days following an increase in the market and sell stocks on days following a decrease in the market tends to emphasize the rise or fall in the market leading to high volatility. On whether the stock markets assist the economy develop, as it ought to, in accordance with the market proponents (Financial Express, 2005), FIIs get at the loss of local investors and the role of FIIs becomes critical. Therefore, the question is, whether such development can add to the economic development of the host country. However, the real question is as how will the FIIs unwind and rebalance their assets and how far can the government safeguard the country's interests against undesirable consequences? In this background this research attempts to examine the effects of FIIs flows on National stock exchange market, and the government role in liberalizing and controlling the National stock exchange (Financial Express, 2005).

1.2 AIMS AND OBJECTIVES

The main aim of the research is to study the impact of FII on National stock exchange and to identify their importance in the development of Indian economy. In support of the above aim the following objectives are set:

1. To study how FII plays an important role in National stock exchange.

2. To study the working mechanism of National stock exchange.

3. To critically analyse the impact of shareholders on the share market.

4. To identify the success and failure factors of FII on Indian economy.

5. To critically analyse various rules set by government for FII participation in Indian stock exchange.

1.3 RESEARCH QUESTION:

Q.What is the impact of FIIs on Indian National stock exchange and to study how effective is government role in liberalizing and controlling the National stock exchange?

1.4 STRUCTURE OF THE DISSERTATION

The dissertation is in five chapters namely introduction, literature review, methodology, data analysis and findings and conclusion and recommendation. Following are the brief overview of the different chapters.

The first chapter gives a brief idea regarding the research. The study has been divided in four major sections as explained above. First section gives a brief idea about the study. The second and third section highlights the aims and objectives and research question on the basis of that the whole study was conducted and last section is structure of the research.

The second chapter gives the information regarding literature related to the different aspect of FIIs and stock market. This chapter provides all the secondary data related to the research.

The third chapter provides the design and methodology for the research. In the design of the outer line of research is explained like research design, research strategy and research approach. Where as in the methodology part the methods of data collection, types of data collected. The chapter intensely explain the different methods for the primary data collected. It also contains the limitations for using these methods for data collection. The chapter also gives the methods used for analysing the data collected. So the chapter provide all details starting from deciding an approach for research to methods of data analysis.

This is the most important part of the research. In this chapter analysis has been made for all the primary data collected from the brokers, mutual funds and financial institutions, FIIS and merchant banks and FII’s of the national stock exchange. The inference of different data collection method has been given in this chapter. All the data was analysed with a view to satisfy the aims and objectives of the research. Some graphs and tables are also used to explain the data analysis more clearly.

This is the last chapter of the research. It provides the conclusion and recommendations for the stock market like NSE (national stock exchange). In the early part of the chapter justification of all the objectives is given to check that all the objectives of research have been satisfied or not. And at last the scope of further research is provided.

CHAPTER 2-LITERATURE REVIEW

2.1 INTRODUCTION

This chapter presents the review of literature relating to the research subject. The chapter is divided into three main sections. The first section discusses the policies of government in India regarding FIIs and also the nature and quantity of FIIs flow. The second section discusses the role and determinants of FIIs in India. The third and last section discusses the role of FIIs in Indian stock market, with reference to National Stock Exchange.

2.2.1 Policies of Government Regarding FIIs

Those entities that the term ‘FII’ broadly covers per se encompass inter alia overseas funds for pension, investment trusts, mutual funds, corporate establishments involved in asset management, companies that serve as nominees, banking institutions, managers of institutional portfolio, funds earmarked for universities, foundations, endowments, trusts instituted for charitable purposes, charitable societies, holder of a power of attorney or trustee established or incorporated outside India seeking to make investments with proprietary purposes or investments from any broad-based fund (which implies a fund involving over 20 investors with none among them holding anything beyond 10 per cent of the units or shares of the fund) (GOI ,2005). In precise terms, FIIs may either make investments from their own funds or they may invest for their clients abroad registered with SEBI. Accounts of such clients managed by the FII are billed as ‘sub-accounts’. A manager of domestic portfolio may also get itself registered as an FII with a view to managing the sub-accounts’ funds.

During the year 2004-05, the overall portfolio investments made in India was approximately 62% of the total overseas investment inside the country. Also, at around 1.29% of the GDP, it went far beyond the existing deficit of account (0.95% of GDP). Investments from Foreign Institutional Investors (FIIs) were as much as 97.5% of it. Right since that point of time when the equity markets of India was opened to overseas investors, investments in terms of FIIs have shown a steady growth from approximately Rs. 2,600 crores in the year 1993 to more than Rs.48,000 crores in the year 2005. The overall flows of FII to India at June 2006-end reached up to slightly beyond 9% of the market capitalization of BSE (Bombay Stock Exchange) (GOI, 2005).

That notwithstanding, there is no gainsaying the fact that the government has shown considerable degree of promptness recently to embark on potent policy initiatives aimed at increasing the flows of FII in India. Not surprisingly, it has evoked a volley of critical remarks from some experts who have gone on to argue that, instead of casting a healthy impact on the economy, inflows of FII have essentially brought the Indian economy under immense burden on certain counts (Rakshit, 2006). Getting to terms with the impacts as well as determinants of flows of FII and working out apt regulatory mechanism have thus come to be recognized as a significant ingredient of India’s economic policy formulation.

Some mammoth FIIs---accounting for below 3% of all the registered FIIs, as GOI (2005) observe----take resort to issuing derivative instruments known as ‘participatory notes’. These are registered as also traded abroad, supported by the Indian Securities’ holdings of FIIs. Such an arrangement has created ripples of concerns among policy regulators at large as it renders it taxing to come out with the funds’ ultimate beneficiary and is vulnerable to being put into practice to make “unhealthy” transactions from funds through unlawful operations thereby causing counter-productive forces to become active in the markets of India.

2.2.2 Nature and Quantity of FIIs Flow

Till mid-July 2006, as many as 932 FIIs were registered with SEBI. Out of these, 115 had got themselves registered during the first half of 2006 itself. In an overall analysis, funds based in US constituted 39% of the entire bulk of registered FIIs. These were followed by those based in UK (16%), Luxembourg (7%) and Singapore (5%). So far as net investment in cumulative terms is concerned, the US based funds had a whopping share of 29% followed by those based in UK (17%) by October 2005 (GOI, 2005).

Despite the fact that FIIs were confined at the outset to investing merely in various listed corporate stocks, these are permitted at present to make investment in bonds, equity and derivative instruments in India in conformity with the limits of overseas ownership for numerous sectors as also ceilings on overall investment per FII. Those FIIs that have a regular inflow, abide by the so-called “70:30 rule”, which precisely implies they are obliged to make an investment of not below 70% of the funds they have in equity-appertained instruments while the rest may be invested in instruments related to debt. Moreover, there are most likely to be certain FIIs which get them registered as “100 per cent debt-fund FIIs”. These are allowed to make investment almost entirely in instruments related to debt. Even though FIIs’ equity holdings have so far captured the attention of the press, policy makers and researchers to the maximum possible extent, it is worthwhile to notice that the FIIs’ debt holdings cannot be overlooked for being not so significant on several counts. (GOI, 2005)

In common parlance of the Indian financial press, FII flows are treated as a key driver of stock market return. Nevertheless, research appears to indicate that they are an effect rather than a cause of performance put up by stock market. Making an analysis of the everyday flow data in course of 1999, it has been concluded by Chakrabarti (2001) that during the period following the Asian crisis, performance of stock market has come up as the only determinant of FII flows, even while monthly data of the period before Asian crisis may indicate a certain degree of causality in reverse way. Such behaviour that is characterized by return-chasing spirit has been corroborated making use of everyday data during the period from 1999 to 2002 by Mukherjee et al (2002). Here, it has also been pinpointed that Indian securities’ sale by FIIs primarily bear the impact of returns instead of purchases. Contrary to this, Gordon and Gupta (2003), in the light of their analysis of monthly data during the period 1993-2000 to draw the conclusion that the flows of FII are akin in a negative way to sagging returns of the stock market, thereby pointing to regressive trading grounded into feedback. However, there are certain issues regarding the propriety of putting in use monthly data for specific types of analysis (Rakshit, 2006). Anyway, keeping in view that a structural break is quite noticeable in the data around April 2003; meticulous analysis of updated data could be desirable in comprehending the nature of causality and relationship between the two variables mentioned earlier.

So far as other features are concerned, Chakrabarti (2001) comes out with no proof indicating any disadvantage of informational type for overseas investor’s vis-à-vis investors from domestic circles. The crisis in Asia brought to the fore a sort of regime shift in ascertaining the magnitude of FII flows. During the period preceding the crisis, the Indian market’s beta with the US S&P 500 index appeared to have inverse impact on FII flows to India. However, this impact went off when the crisis came to an end. The country risk rating of India apparently made no impact on the flows of FIIs. The motive of diversification leading to FII flows to India has been questioned by Mukherjee et al (2002) who report inertia or autocorrelation in it. According to Gordon and Gupta (2003), FII flow shows sensitivity to the London Inter-bank Offer Rate (LIBOR) as also the macroeconomic fundamentals of India. Likewise, it has been argued by Coondoo and Mukherjee (2004) that both the FII flows and stock market in India have a kind of volatility that is high and related. Eventually, Bose and Coondoo (2004), in their analysis focused on the impacts various regulatory measures have had on the flows of FIIs, observe that policy change liberalization have cast effects of expansionary type on FII flows whereas measures of restrictive kind devised to give regulators more control over the flows of FIIs do not always thwart them.

India’s policy circles hold that flows of FIIs are most likely to throw a fairly positive effect on the development of the country; and this happens to such an extent that the flows of FIIs – while bringing down the vulnerability of financial sector to speculative flows of capital – lend credence to one of the key objectives of the present regime’s National Common Minimum Programme. As such, an expert group was established in 2004 (besides a committee in 2002 which reported in 2004) to indicate ways to achieve this goal. In November 2005, the group submitted its report to the Government. Its rationale for encouraging FII flows is that such flows can increase domestic investment without increasing foreign debt. They can raise stock prices, lower cost of equity and stimulate investment by Indian firms and lead to improvements in securities market design and corporate governance.

In order to further stimulate FII flows, the expert group has suggested setting FII investment caps, if any, over and above the Foreign Direct Investment (FDI) sectoral limits. In cases where the limits have to be combined, they should be set at sufficiently high levels. Another recommendation (GOI, 2005) is to increase the supply of “good quality equities” through disinvestment in the public sector and through encouraging companies with large projects like those in infrastructure and telecom sector to raise money in the domestic markets.

So far as the accompanying objective of bringing down the vulnerability of the market to abrupt flows is concerned, the group makes recommendation for the institutional investors operating at domestic front such as pension funds in various equity markets. Those entities that belong to the so-called “tax haven” countries ought to be prohibited from getting them registered as FIIs (GOI, 2005). It is viable to allow the prevalent practice billed as participatory notes (PNs) to get wider acceptance if only SEBI is invested with the powers to reach out to the final beneficiary with a view to surveillance or investigation just by rendering it imperative for numerous FIIs to yield this type of information. It could bear counterproductive fallouts if PNs are issued to such entities which are not regulated in any country or region across the globe. Moreover, FIIs are always required to show strict conformity to what has come to be known as “know your client” principle. Non-eligible PNs that are extant ought to be permitted to lose their currency naturally or become shorn of their significance within a duration of half a decade in any case. Besides, in order to avert the gross abuse of what is known as the subaccount route to manipulatively circumvent the limits of investment, the limits of FII ought to be put in application to the entire investment profile that an FII manages either directly by way of its sub-accounts.

The fundamental premises on which beneficial impacts of the flows of FIIs in India rest as also the recommendations of the expert group in this regard have been questioned by Rakshit (2006). Besides the risks that instability causes to crop up, which Rakshit(2006) looks upon as belittled by the group of experts , he categorically pinpoints that in course of the period from 1992 to 2002 , a rather shallow relationship has existed between the balance of capital account and total investment in India . Actually, as he further observes, save for a brief period of two years, the current account balance has been exceeded by the latter throughout the period since the beginning of liberalization.

It brings this to the fore that the flows of FIIs are making prime contribution to the accumulation of vast hoards of foreign exchange reserves with the RBI instead of aiding by any standard tangible investment growth in the economy. Besides, such an accretion in terms of reserves suggests substantial hike in costs for the economy in the light of a decline in RBI profits through holding of less productive reserves, erosion of the so-called seignorage revenue as also the costs to be borne for inflow sterilization. With the economy increasingly coming under the pressure caused by deficiency in demand, the true impacts of increase in FII flows may not positive at all. So, the flows of FII should primarily be seen not in complete exclusion from, but as a component of the whole policy package encapsulating numerous receipts of capital and taking into account the role they play in the entire macroeconomic structure (Rakshit, 2006).

2.3 FOREIGN INSTITUTIONAL INVESTMENT (FII) IN INDIA: ROLE AND DETERMINANTS

2.3.1 Role of FIIs

Besides all such changes that have been referred to earlier, the market throughout the world has also experienced an increasingly prevalent trend of ‘institutionalization’, which we may consider to be an outcome of the phenomenon called globalization. In more precise terms, the strength of an enormously increasing number of institutional investors with the prime objective of investing the assets they own themselves or those they are entrusted by others is noticeable almost ubiquitously. Among these, the commonest are the portfolio investors and mutual funds. At present, big institutions take control of large sums of money that are kept in a mobile state by them continuously. So far as Japanese and European markets are concerned, it is the institutions that dominate almost all the trading. Throughout the US, retail investors continue to participants dynamically (RBI, 2005).

Over the past one and a half decades, one very significant feature of stock market development in India has been the constantly increasing participation of Institutional Investors, including both the mutual funds in India and foreign institutional investors (that is because the pension funds continue to be confined to almost entirely participating in the stock market; had it not been so, these funds are remarkable drawers throughout the world) (RBI, 2005). At the backdrop of the increasing reform trends, Indian stock market is set to experience institutionalization to a much greater degree besides more substantial volume of money under its belt. In that situation, such community of investors is poised to essay a key role in the equity markets of India. The basic significance of institutional investors and specifically investors from abroad is quite visible as an extremely common reason that the experts of market offer whenever rising trends in the market come to light. Such rises are essentially attributed to the money of overseas investors. Not surprisingly, several headlines and budge words have achieved unprecedented currency via the business press (RBI, 2005). It should not be something quite unusual in the context of India only because a large majority of developed economies at present might have seen an analogous past trend.

Institutional investors’ increasingly important role has triggered both qualitative and quantitative developments in the arena of stock market encompassing securities business expansion, more breadth and depth of the market, and most importantly, their philosophy of dominant investment through which they stress the significance of the basics has led to efficient stock pricing (RBI, 2005).

Policymakers have been compelled by a serious Balance of Payments (BOP) situation to have another look at their bid to permit overseas capital into the country’s market. During 1991, some measures seeking to bring in discipline on fiscal count besides reforms in the operational arena of external sector were announced rendering it possible for overseas capital to pour into the country. In the Indian stock market, there were as many as 685 (ISMR 2004-05 NSE, Mumbai) registered foreign institutional investors on March 31, 2005. Till that date, the overall cumulative investments FIIs made were approximately USD 35.9 billion --- about 6.55% of the total capitalization of market in India. Since they got permission to make investment in India it was marked by a steady increase save during the year 1998-99. In overall terms, the net inflows reached the average of about 1.1 billion annually with no large outflows except for the year 1998-99 where a majority of South Asian countries had lost ground for some time. Overseas portfolio investment has a sort of infamy attached to it since it tends to flow in reverse direction from the very beginning (RBI, 2005). Such a tendency germinates from the nature of investment of FIIs itself - portfolio managers have a tendency to rebalance and restructure their portfolios in a dynamic way throughout different global economies and their principal motive is to their portfolio in a good shape. Due to the volume of flows shown by them, the FII investments are directed primarily towards making or breaking a market’s fortunes.

Table 1- Net Investment by FIIs:

Year	Net Investments by FIIs (Rs. Cr.)
1992-93	4.27
1993-94	5444.60
1994-95	4776.60
1995-96	6720.90
1996-97	7386.20
1997-98	5908.45
1998-99	729.11
1999-00	9765.13
2000-01	9682.52
2001-02	8272.90
2002-03	2668.90
2003-04	44000.03
2004-05	41416.45

Source: RBI (2005)

Because of the fact that FIIs are not statutorily obliged to go public, those establishments wherein they make investment hardly have any information on this specific aspect that can be brought to the notice of the common public. Nonetheless, the entire investment profile regarding all Flls in the equity base of any company gets monitored by RBI, which sends to the former a caution notice, in case the total volume of FII investment attains a 22 percent mark in a particular company. Thereafter, it has come to be adopted as a regular practice categorically pronouncing that different types of purchases ought to be done only when RBI grants approval for them. At the backdrop of such monitoring reports, it can be possible to get a tangible answer if it is apt to consider Flls as a market builder on their own. In this respect, it is worthwhile to take note of the fact that a majority of stocks which figure in the portfolios of institutional investors are such securities anyway which comprise the Sensex or Nifty indices so much that movements taking place simultaneously and involving the institutional investments and index is probable. However, in case we make use of Advances and Declines ratio (ADR hereafter) the direction characterizing the market can be ascertained in unequivocal terms (RBI, 2005). In general, the advances aimed at catching the ratio of declines point to the market’s breadth. So, we apply ADR rather than Sensex or Nifty returns. As a matter of fact, it is not practically feasible to put away the actions performed by FIIs and mutual funds on the stock market, because the two-investor categories are working at the same time. Therefore, the activity at institutional level is observed by keeping track with the ratio of mutual funds-FIIs’ combined purchases to mutual funds’ combined sales.

Stock markets of India have become quite mature due precisely to the several developments that have taken place over the past one and a half decades rendering these markets almost as advanced on all counts as their counterparts in developed nations. One of the most significant characteristics of various developed markets can be singled out as the increasing influence of institutional investors. The proposed paper aims to bring into focus whether markets that we have are also experiencing the dominance of institutional investors. The results in terms of regression reveal that the strengths of mutual funds and Flls together may be treated as a potent component of the market, capable of setting trends and directions of the latter. The Granger causality test, by making use of the direction taken by the funds’ flow from mutual funds as well as Flls, has exhibited that the mutual funds actually spearhead the rise or fall of the market with Flls following suit. It may, as a matter of fact, raise concerns regarding the efficiency of the market. Contrary to the common perception, however, markets tend to show more efficiency due to the increasing prevalence of institutional investors keen to primarily go in the light of numerous fundamentals. In Indian context, for instance, noise trading by institutional investors may not be so much precisely because all the trades they do are based entirely on delivery (RBI, 2005).

2.3.2 Determinants of FIIs

According to IAPM, regarded as the standard international asset pricing model, liberalization of stock market is likely to bring down the cost of equity that the concerned country bears by creating scope for the sharing of risk between foreign and domestic agents (Henry, 2000b). In the wake of the liberalization of stock market, people ought to be able to notice a rise in the equity price index of an emerging economy. Henry put into application the approach of event study to elaborately deal with the problems such as stock markets exhibiting unusual magnitude of returns as also a reduction in yields accruing from dividend following the liberalization of stock market. The research focuses on a dozen emerging markets where the outcomes clearly bring to the fore that emerging economies underwent the experience of abnormal monthly returns of 4.7% on an average in real terms of dollar in course of an eight-month window eventually resulting in the execution of the initial phase of stock market liberalization in the context of an economy. Yet another study conducted by Henry (2000a) took this observation further by pinpointing that sample developing economies had unusually high rates of growth in terms of private investment following the liberalization of their stock markets. In a similar type of research, Bekaert and Harvey (2000) tried to find out if the liberalization of stock market result in changes in equity capital cost in the context of emerging economies.

The kind of linkage that exists between the volatility of stock market and the phenomenon of liberalization has been investigated in an elaborate way as well. In this regard, a framework of cross-sectional nature was made use of by Bekaert and Harvey (1997) with a view to studying if the liberalization of capital market throws any concrete impact on volatility. From the empirical study results, it has been brought to light that a majority of economies which have undergone the experience of liberalization have also experienced decreases in the magnitude of volatility. To cite some specific instances, Argentina, Mexico, Brazil, Taiwan and Portugal have registered dramatic declines in volatility depending on certain conditions prevailing in the market.

In their study, Kwan and Reyes (1997) have made it clear that a free market can be the best type of approach for facilitating the process of economic development in what has come to be recognized as neoclassical economies. Nonetheless, stock markets’ liberalization is generally a fairly controversial type of issue in developing economies. It has been suggested by the avowed champions of this phenomenon that the liberalization of stock market may have several advantages for developing economies. To begin with, it is capable of filling in the voids that characterize disposal of savings for the requirements of domestic investment. Secondly, it is of immense help in efficient dissemination of the resources considered vital for investment. Thirdly, it holds considerable significance as a means for infusing discipline among various managers of corporate establishments. Fourthly, it has been pointed out by the supporters of stock market liberalization that this phenomenon allows comparatively little dependence on the financing of debt. Contrary to this, the opponents of stock market liberalization point out its certain disadvantages. Firstly, they point to the absence of any commitment needed for stability in the context of fixed investments in real terms. Secondly, an emaciated ability for the operational machinery of the government to execute its policies of industrial development. Thirdly, as they further assert, stock market liberalization also aggravates susceptibility to overseas politico- economic turmoil’s or speculations.

Furthermore, it has been indicated by Kwan and Reyes (1997) that Taiwan has emerged as a powerhouse in the world economy, especially in the Asia-Pacific region after going beyond reasonable expansion that its domestic economy has undergone. It has been shown by them that liberalization of policy has gone on to bring down volatility in Taiwan’s stock market. As they observe, the stock returns of Taiwan are more efficient in information processing apart from being less volatile today than the pre- liberalization period.

The major focus of Wang and Shen (1999) is the likelihood of foreign investment getting destabilized or impacts of demonstration on the stock and foreign exchange markets of Taiwan. Of the key findings with which they have emerged, the first one is that foreign investment throws a healthy impact on the volatility underlying the exchange rate, implying that inward remittances of overseas investment may enhance the exchange rate volatility, whereas the externally flowing remittances are not likely to do the same. Another salient finding is that foreign investment does not affect the volatility of stock market substantially. Eventually, stock returns bear the impact of no fundamental factors only prior to foreign investment inflow. Despite all these, following the foreign investment inflow, both non-fundamental and fundamental factors are likely to impact stock returns.

In this regard, yet another interesting study has been undertaken by Beer and Vaziri (2004). The prime focus of their investigation is the distribution of returns, performance of and volatility underlying a novel set of emerging markets which continue to be under research. They essentially concentrated on the founding members of the Federation of Euro-Asian Stock Exchange (FEAS), putting into application the conventional performance measures adopted by Treynor, Sharpe and Jensen. Analyses made by them brought to the fore that Tehran associated with the FEAS exchange alone outperformed the S&P500. Besides, it was indicated by result that in case securities at domestic level are linked with the securities of FEAS, the portfolios combined together remarkably outperformed a portfolio that included only domestic securities.

The exit market’s functioning as also the opportunities for divesting investments are crucial for the ability of venture capitalists to come to terms with profits and concentrate primarily on the core areas of its functioning such as monitoring and management of small ventures (Black et al., 1998, Sahlman et al. 1990). The restricted spread of financial markets at domestic level limit the opportunities of trade sale and financing for entrepreneurs and investors of venture capital who have the ability to pave way for the creation of value from the investments devoted to science and technology. Keeping in view the fact that researches focused on venture capital markets that have been undertaken earlier have almost invariably arrived at the conclusion that a deep and broad exit market serves as a major determinant of a flourishing venture capital market, it is of critical significance to make sure that there will be sufficient opportunities of exit for venture capitalists while evolving a national environment for innovation (Black et al., 1998). So, any viable access to opportunities of foreign exit holds specific relevance for tiny open economies characterized by robust investment prospects in the arena of innovation, science and technology.

In spite of the pronounced significance of foreign exit for various entrepreneurs as well as their investors and the political leadership of small open economies looking after the marathon task of evolving the national environments for innovation, numerous factors impacting foreign exits in a successful way have not been accorded considerable scrutiny beforehand (Here, Hursti & Maula, 2002) stands out as a striking exception).

Research undertaken earlier has revealed a robust tendency among investors to attach priority to close cultural and geographical investments (Coval et al., 1999; Grinblatt et al., 2001). Such an obvious bias for ‘home’ is considered to have been rooted in bias in cognitive terms towards the familiar (Huberman, 2001), ability of investors to get hold of local information and thus much better returns (Coval et al., 2001), numerous fiscal frontiers, as also incomplete information at investors’ disposal on the current targets of investment (Merton, 1987). The prospects of the ventures poised to have ownership in a restructuring mould so as to explore novel investors beyond their domestic markets are gravely hampered by such a tendency to stress the importance of investments at local level. It can be argued here that the presence of an overseas investor of venture capital and indirect links with foreign VCs by way of networks of syndication of domestic investors can be helpful in lessening these problems by giving boost to awareness among potential investors regarding the venture and mitigating the weight of negative underpinnings carried by problems such as overseas investment targets’ illegitimacy and asymmetric information.

On account of the costs incurred on receiving information, the investors may end up with imperfect and differing endowments of information. It may lead to complete unawareness regarding overseas opportunities of investment and thus a critical barrier of information between the venture itself and potential investors. An investor of foreign capital from abroad may operate as a sort of connecting bridge between the venture on the hand and the prospective novel investors (Mäkelä & Maula 2004a). Though the mass media has the ability to provide certain beneficial tips and bits of information regarding a particular venture, the prevalent socio-institutional links and networks of an overseas venture capitalist have fairer chances of being effective on this count when they are focused on potential investors. Despite the fact that it could also be possible to contract such investors across borders, the cohesiveness and intimacy in terms of relation enhances the effectiveness that this knowledge transfer can have (Reagans et al., 2003). It is possible for the overseas investor to make use of its current contacts so as to extend promotion to the venture and boost the possibility of pulling in novel overseas investors.

While direct contacts are capable of yielding higher volume of information as also more comprehensive gamut of information, indirect contacts may enhance the reach as well as diversity of network of contact (Koka et al., 2002). So, a direct contact may not necessarily be required by an overseas venture capitalist for the purpose of the transfer of information, in case the contacts at the investor groups’ disposal facilitating its easier access to overseas investors serve as a connecting information channel between the potential investors and the venture itself. Comprehensiveness of the network of indirect ties accessible to the venture by way of its group of investors is directly proportional to the range of the information diffusion that in turn affects the magnitude of foreign exit.

While the literature focused on financial aspects concerns the precision and credibility of information, an argument of complementary nature to the effect of certification emerges from the literature on endorsement, which puts forward the suggestion that the venture’s affiliations with prime functions of organizations may be treated as connotations of legitimacy directed towards the prospective investors (Feldman et al., 1981; Higgins et al., 2003). Links with different other organizations may also have an important role to play in determining the venture’s social standing as well as the status of transfer from leading partners (Stuart et al., 1999). The kind of social context which the prospective investors and venture capitalist shares facilitates the way the symbolic affiliations can be construed thereby legitimizing the venture as a target of investment.

A number of attempts have been made so far to throw light on the behaviour of FIIs in India. In all the studies that exist on this subject it has been observed that the return of equity has a positive and significant influence on FII (Agarwal 1997; Chakrabarti 2001; Trivedi and Nair 2003). However, keeping in view the enormous investment volume, overseas investors may essay market makers’ role and foresee their profits, by resorting to the purchase of financial assets in case they find the prices go down, so that they can get the best out of asset prices, and sell once an increase is registered in the asset prices (Gordon and Gupta 2003). Therefore, a probability of bi-directional relationship involving FII and equity returns arises.

In the wake of the financial crisis in Asia and the outbreak of the IT revolution globally during 1998/99, a decline was recorded in FII which was estimated up to U.S.$61 million. Nonetheless, this cast very little impact on the status of equity returns. Such a counter-productive investment could perhaps impede the long-standing relationship between the FII and numerous other variables like returns of equity, inflation, etc. According to Chakrabarti (2001), there has been a paradigm shift in the prevalent set of determinants of FII in the wake of the financial crisis in India. He observes that during the period preceding Asian crisis, any change triggered in FII threw a healthy impact on the returns of equity. However, it has been noticed that during the period that followed Asian crisis, a reverse sort of relationship has come to light, and namely, indicating that change in FII can be attributed primarily to change in the returns of equity. It is something which deserves substantial attention in any FII-centred empirical investigation. Foreign or domestic investments bank mainly on factors causing risk. So, in course of the study of FII behaviour, it is crucial to take note of the variables of risk. Moreover, it is possible to divide realized risk into unexpected and ex-ante risks. Of these two, ex-ante risk may be of particular significance as some type of observed ingredient negatively appertained to FII. However, the relationship involving FII and unexpected risk is vague. So, while investigating the effect of risk on FII, it is required to differentiate the unobserved ingredient from risk that is realized. Only the realized type of risk has been used by Trivedi and Nair (2003).

Yet another likely FII determinant is foreign factors’ operation which include returns in the financial markets of the source country as also various other factors ingrained in the latter’s economic landscape. To this date, studies have, however, come to the conclusion that both the rate of inflation and return in the stock market of the source country have failed to cast any big impact on FII. It has been found by Agarwal (1997) that capitalization in stock market across the world could throw a positive impact on the India-oriented FII.

From a survey centred on the literature, it has been brought into focus that studies prevailing today do not highlight the true face of volatility (the so-called ARCH effect) --something that can certainly be hoped in a majority of the monthly data related to financial time series. Nonetheless, keeping in view the increase in the integration of financial market, including both foreign and domestic financial markets, volatility accounting is indispensable. Moreover, the prevailing studies may not encapsulate risk in domestic and foreign markets. It may also use realized risk that is realized, an approach which does not necessarily give healthy results.

2.4 FOREIGN INSTITUTIONAL INVESTMENT (FII) IN INDIA AND STOCK

MARKET

A very significant feature of globalization in the specific industrial context of financial services is the enhanced access offered to investors of non-local type in the world’s numerous key stock markets. On an increasing scale, stock markets belonging to emerging markets allow investors with institutional objectives to make trade in their respective domestic markets. Such an opening up of various capital markets in the countries of emerging market has been considered to be advantageous by quite a few researchers whereas others show a great concern for likely consequences of negative nature such as contagion (Clark and Berko, 1997).

A considerable amount of stress has been put by Clark and Berko (1997) on the advantageous impacts of permitting foreigners to make trade in various stock markets and present an outline of the hypothesis that favours “broadening of base”. The advantages of the broadening of base emerge from an enhancement in the base of investor as also the resultant reduction in the premium of risk on account of the sharing of risk. Some other people associated with the fields of research as also policymaking exhibit greater degree of concern regarding the underlying risks associated with the trading operations of overseas investors. In particular, they seem to be more concerned regarding the herding behaviour of overseas institutions as also the possible destabilization experienced by stock markets on rise.

India offered the foreign institutional investors access to its market in September 1992. It has been regarded as a landmark event as it led to effective globalization of its financial services sector.At the outset, several funds like mutual funds, pension funds, Asset Management Companies, investment trusts, incorporated/institutional portfolio managers and nominee companies were allowed to make direct investment in the stock markets of India. Starting in the year 1996-97, the group underwent an expansion so much as to encapsulate registered funds earmarked for universities, foundations, endowment, charitable trusts and so on. From that point of time onwards, flows of FIIs that constitute a part of portfolio investments from foreign countries have been becoming more and more important in the Indian context.

Though the flows were stymied by East Asian crisis and nuclear tests, Gordan and Gupta (2003) have aptly observed that their impacts were long-lasting. In terms of percentage, BSE’s total net turnover – that is the average share of FII purchases and sales went up from 2.6 percent in the year 1998 to 5.5 percent in the year 2002.Overall net investment of FIIs in India as in August 2003 was about $17400 million. It was approximately 9 percent of the market capitalization of BSE which is comparatively small vis-a-vis market size. Nonetheless, as it has been put by Banaji (2002), what actually matters is not the capitalization of the market but the free float level, which implies the shares publicly available in real terms for trading. As floating stock in the market of India is below 25 percent, approximately 35 percentof the available magnitude of free float has got to be covered by FIIs – in spite of the fact that they make investment in only some extremely liquid stocks (Banaji, 2002).

Even though India gets just about 1 percent of the investments of FII in emerging markets, lesser degree of volatility has been observed in case of the flows of portfolio to India when they are seen in close comparison to the same in the context of several other markets of emerging nature (Gordan and Gupta, 2003). Through the adoption of FIIs , a bottom-up type of approach appear to make investment in excellent quality, considerable rate of growth, vast cap stocks and so on (Gordan and Gupta, 2003). Providing empirical evidence, Sytse et al. (2003) categorically infer that foreign institutional investors making investment in India choose big, liquid corporate establishments that may enable them to back out without any considerable hassle and at comparatively little cost. They also observe that the foreign institutional owners may cast a bigger impact than overseas corporate owners as it can be noticed when performance is gauged by making use of the valuation criterion of stock market.

Keeping in view the fact that India is among South Asia’s most rapidly growing economies, currently registering an over 6 percent growth, next to none but China, it should not be seen as something shocking to notice more flows of FIIs to India in the days to come. Now, FIIs are visualizing the economy in its entirety, while the factors of macro-economic nature also play their part in drawing overseas investors. Factors such as a robust currency, major banking reforms besides those in power as well as telecommunications sector, greater volume of consumer spending and enduring policies are likely to have a significant part in drawing FIIs to India. The SEBI and ICAI together monitor various markets besides making announcements regarding the regulatory measures and thereby rendering Indian corporate establishments more disciplined and transparent.

It has been stressed by Banaji (2000) that the reforms in capital market such as better transparency in the market, dematerialization, automation and regulations on the standards of disclosure and reporting were started due to the prevalence of the FIIs. However, the flows of FII can be viewed not only as the cause but also the effect of reforms in the capital market. Market reforms have been introduced on account of the existence of FIIs, which has resulted in an increase in flows.

FIIs were accorded preferential treatment by the Government of India till about the year 1999-2000 and as such their capital gains of long-term were subjected to lesser rates of tax up to 10 percent whereas investors at domestic front were made to pay more tax for capital gains for long-term. The Indo-Mauritius DTAC 2000(Double Taxation Avoidance Convention 2000) grants freedom to Mauritius-based entities from the obligation of paying tax on capital gains in India. It precisely includes tax on income from shares’ sale. It offers an incentive for overseas investors who can invest in the markets of India by choosing the Mauritius route.

It has been pinpointed by Chakrabarti (2002) and Rao et al. (1999) that because of prevailing inter-linkages, the country wherefrom the institution operates may not exactly be singled out as the source of the investment of FII. Despite that, the figure may give us a glimpse of the FIIs’ country wise distribution inside India. With a view to promoting investments for long term in the markets of India , it was proposed by Budget 2003 that investors buying listed corporate establishments’ stocks from March 1, 2003 be granted exemption from the payment of tax on capital gains made by them on their investments, in case those gains are held by them for over one year. Given the magnitude of benefit underlying such measures, the investment of FII in India may increase in the days to come.

Substantial rise in flows evoke possibilities of additional flows in future. Such possibilities are mirrored in the existing increase in price which naturally gives a boost to the hopes of more flows in future. In case the expected degree of flows is not expressed in material terms in future, there is a decline in prices (Froot et al., 2001). Popular hypothesis of price pressure states that the hike in prices is essentially appertained to increase in inflows; on the basis of it, it can be expected by us that prices get back to the original position with the actual flows being incapable of matching the flows that are expected in future. It has been posited by Warther (1995) that price rise occasioned by surges in inflow can be attributed to illiquidity prevailing on a temporary scale and this kind of theory forecasts that the prices are going to get back to their normal level. Such a theory may appear to be quite germane in the specific context of the type of emerging market that India is.

Now let us take a look at the seasonal pattern in the average flows of FII to India on monthly basis. In keeping with Rao et al. (1999), it can be shown clearly by the graph that January experiences maximum inflow and with the progress of the year, the flow (purchases in particular) goes on declining. It might be possible for the fund managers to invest much of the funds devoted to a particular market, at the start of the year while the investment gets down in subsequent months following reduction in funds available for this purpose. An interesting observation has been made by Rao et al. (1999) who say that BSE Sensex as well as investments of FII registers a definite decline during the fourth quarter due perhaps to the players of local market looking in the direction of FIIs for getting leads.

Investments of portfolio cause risk for overseas investors, offering an opportunity to have a share in the benefits of growth in developing nations that are likely to grow by a greater pace. Investment in various emerging markets may give more return on investments for funds related to pension as also investors with private interests hailing from developed nations. So far as developing economies are concerned, foreign investment in portfolio equity may have distinct implications and characteristics bearing little resemblance with those of FDI. Apart from supplementing savings at domestic level, FDI may also be helpful in technology transfer, initiating novel marketing and management skills, and facilitate the expansion of the foreign trade and markets of the host country

(World Bank, 1997, p. 31).

In essence, portfolio investments are supplementary to the availability of foreign exchange as also domestic savings. However, they are usually not specific to any project. Generally, FPIs are accorded welcome in developing economies because these create no debts. In case these are involved in various primary issues, FPIs provide very significant risk capital for novel ventures. Because FPIs assume the form of investment in a secondary or subsidiary stock market, it makes no direct contribution to the creation of any novel capabilities of production. In order to enable the flows of FPIs that call for easy liquidity, numerous multilateral organizations, spearheaded by the International Finance Corporation (IFC), have persistently been extending encouragement to the establishment and consolidation of stock markets in various developing nations as a means facilitating savings’ flow from developed economies to developing ones (World Bank, 1997).

There are some genuine expectations that FIIs could be helpful in attaining greater liquidity at different stock markets, enhance ratios of price-earning (PE) and thereby bring down capital costs for investment. It is also expected that FPI may bring about improvement in stock market operations with portfolio investors from abroad keen to invest in the light of properly planned strategies as also a realistic valuation of stock . In common parlance, the portfolio investors have the reputation of being very sound analysts with access to numerous information, experience and data regarding operations in considerably different politico- economic ambiences. Those host countries which are on the lookout for foreign portfolio investments may be compelled to upgrade their delivery and trading systems which may benefit the local investors as well. With a view to retaining portfolio investors’ confidence, host countries may follow steady and business oriented policies of liberal nature. With considerable access to huge funds, overseas portfolio investors can impact the capital markets of developing economy in a remarkable manner particularly in big domestic investors’ absence (World Bank, 1997).

There are several macroeconomic implications underlying Portfolio investments. Though they are supposed to make substantial contribution to the consolidation of the pool of foreign exchange reserves, it may be stated that portfolio investments might impact the rate of exchange with the potential of causing local currency's appreciation artificially. Eventually, it might prove to be detrimental to the spirit of competitiveness. Moreover, portfolio investments also show susceptibility to abrupt withdrawals which is why the counter-productive potential of bringing in waves of instability for an economy cannot be overlooked in case of these investments. The FPI's volatility is influenced to a reasonable degree by various opportunities arising globally and flows across different countries. Even though FDI and FPI bear some resemblance for being volatile in quite the same way (Claessens et al, 1993), the fact that portfolio investments can be more risky on that count has been amply highlighted by the Mexican and East Asian crises.

Despite the fact that foreign portfolio investments cannot be seen as a new phenomenon to the corporate sector of India, the significance of portfolio investments attracted particular emphasis by 1992-end when various types of Foreign Institutional Investors (FIIs) including Mutual Funds, Pension Funds, Investment Trusts, Nominee Companies, Asset Management Companies and Managers of institutional/incorporated Portfolio were allowed to make direct investment in the stock markets of India. FIIs' entry appears to be a corollary to the recommendation made by the report of Narasimham Committee on Financial System. Although the Report recommended their entry, it hardly expatiated upon the objectives of the policy suggested. The only statement made in the Report was: The Committee would also suggest that the capital market should be gradually opened up to foreign portfolio investments and simultaneously efforts should be initiated to improve the depth of the market by facilitating issue of new types of equities and innovative debt instruments

(Narasimham Committee Report, 1991, p. 121).

Drawing the pool of foreign capital seems to be the prime motive behind stock markets opening up for FIIs from all corners (Lalitha, 1992). On September 14, 1992, the Government of India laid down pertinent Guidelines for the investments of FIIs. Just a few days earlier, a statement issued by IFC implied that India could have to keep waiting for quite some prior to the taking shape of expected huge foreign investment (Financial Express, 1992).

Despite the fact that an important place has been accorded to FPI in the financial sector of India under the package of liberalisation, only a few studies based on the FIIs' Indian operations exist. A major reason can be had in the dearth of data. Most of the empirical studies have stayed within the confines of studies at aggregate level (Joshi, 1995; Pal, 1998: 589-98; Samal, 1997: 2,729-32). These studies usually indicate the positive relationship between FII investments on the one hand and the movement registered by the Bombay Stock Exchange share price index on the other. While undertaking the present research we noticed the relationship a bit differently. In order to provide better empirical content to the common understanding that FIIs impact the equity markets of India we made attempt to get hold of detailed data on the transactions of FIIs. However, the attempts to have FII-wise information from the SEBI as well as RBI failed to bear any fruit. Keeping that in view, it banked upon other sources. In the phase of March 2000, the count of FIIs registered with SEBI was 502. However, number of FIIs alone does not give any complete picture of the operations of FII in India because every FII can imply countless subaccounts (Samal, 1997).

But on the number of sub-accounts, hardly any information of reliable nature is at our disposal. Due to the importance of sub-account-wise limits of investment one might have hoped that SEBI would yield relevant bits of information in that regard. Moreover, quite a large number of FIIs are controlled commonly (as suggested by the names they bear, their addresses as well as telephone numbers) and make the limits of individual FII less germane (Samal, 1997).

From the above discussion, it comes to the fore that mutual funds are gaining prominence in the Stock market of India and that (i) the share of foreign affiliated MFs is growing, (ii) a number of Indian funds are following the investment strategies of the foreign ones, (iii) there are sector specific funds for IT, Pharmaceuticals and FMCG, (iv) schemes of many funds focus on these sectors without actually claiming themselves to be one such. It further explains the sector-wise developments in the stock market of India in course of 1999. A thoroughly focused effort could have pushed to the background the importance of the other sectors and widened the differences in P/E ratios between the so-called new economy sectors and the others.38 The latest change in Sensex announced by BSE further admits the enhancing significance of IT, media as well as pharmaceutical companies (Economic Times, 2000).

Others promoting sector specific funds include: Birla Mutual, IL & FS, Kothari Pioneer, Prudential ICICI, SBI Mutual and Tata Mutual. It is of special interest that despite being a non- sector specific fund, JM Equity Fund’s reliance on the software sector went up from 34 per cent in September 1999 per cent at the end of December 1999 (Gulati, 2000) It can thus be expected that progressively stock prices would be affected not only by net FII investments but also the size of funds under control of their local counterparts. While FIIs can remit capital and profits back to their home countries, the local affiliates will have to invest in the domestic market only (SEBI, 1999). Yet another development during 1999 which affected share price movement in India is the listing of Infosys Technologies and Satyam Info way, a subsidiary of Satyam Computers, on Nasdaq of USA. Now, It is held in the circles of stock market that prices of information technology companies in India are influenced by the Nasdaq (Economic Times, 2000). This phenomenon is going to be increasingly prominent as more and more Indian companies get traded abroad.

Increasing trading concentration in some sectors could bring down the base of stability for the stock markets. It has been expected that by providing more liquidity to local markets, oversees investments would reduce the volatility which results from the thinness of the markets in developing economies may thus prove unfounded. So far as the incentive of lower tax is concerned, FIIs have apparently tried to circumvent even the low taxes by using Mauritius as a shelter. Ultimately to provide a level playing field, even the domestic investors had to be offered lower rates of capital gains tax (Economic Times, 2000).

Analysing from the standpoint of monitoring corporate managements, one can say that the FIIs and large domestic financial institutions together can play a useful role to force company managements improve their performance and refrain from indulging in mal-practices and investor-unfriendly decisions as together they hold substantial shares in many large Indian companies. Such an argument is based on a weakness that the FIIs are unable to stay attached to one company only. These are expected to put pressure on diverse sets of management through their operations on buying or selling front. Contrary to this, government through holdings controlled by it, in the long-term interest of Indian industry can, if there is political will, take a firm stand. There are also other problems with utilising foreign portfolio equity for monitoring domestic companies. It is hard to surmise or speculate how much of the such equity is in fact return of the flight capital. If such situation arises, the so-called FII investment will merely support the existing managements. Even if it is accepted that FII investment could be helpful in monitoring, due to their propensity to invest in a few liquid shares, the problem of monitoring a large number of companies still remains (SEBI, 1999).

It has been suggested in the light of existing trends that the stock market of India may emaciate its relationship with the economy at large with its focuses on some sectors exclusively (Economic Times, 2000). The question is whether the developing countries can bank upon the wisdom of the stock market, particularly if it reacts to external factors, for industrialising their economies is a question that needs to be examined in greater detail. After this phenomenon has been initiated and stressed by FII operations gives rise to a doubt whether foreign portfolio investments would serve the objective of local stock market development or the tangible benefit from them would only confine to getting the balance of payment support along with its attendant risks.

CHAPTER 3-RESEARCH METHODOLOGY

3.1 INTRODUCTION

A research is focused to examine the particular research problem stated. Obviously this research was also purposed to examine the particular problem stated. The problem statement of this research was to examine the impact of FIIs on Indian stock market. In order to solve the research problem and underlying issues it required for the researcher to collect specific data or information. Collecting data required adopting specific methodology or research methods. This chapter is all about detailing the applied methodology in the research. The sections of the chapter are: research method, data collection method, data analysis method and limitation.

3.2 RESEARCH APPROACH

The research methodology literature lays down that a research can be as deductive or inductive (Saunders et al, 2005). Adopting deductive research operationalises identified concepts in a mode that enables facts to be measures quantitatively. Whilst adopting inductive approach researcher gets feel of what is going on so as to understand better the nature of the problem. In this research deductive approach has been put to application, where identified concepts and variables have been operationalised in a mode that has enabled the researcher to collect facts and quantitatively for meeting research objectives.

3.3 RESEARCH DESIGN

Researches may be either exploratory in nature or descriptive, or may be conducted to test hypotheses (Sekaran, 2004). The case study, which is an examination of researches done in other similar organizational situations, is also a method of solving problems, or for understanding phenomena of interest and generating further knowledge in that area. The nature of the research -whether it is exploratory, descriptive, or hypothesis testing-depends on the stage to which knowledge about the research topic has advanced. The design decisions become more rigorous as we proceed from the exploratory stage, where we attempt to explore new areas of organizational research, to the descriptive stage, where researchers try to describe certain characteristics of the phenomena on which interest centres, to the hypotheses testing stage, where researchers examine whether or not the conjectured relationships have been substantiated and an answer to the research question has been obtained (Sekaran, 2004).

This research is classified as exploratory, where the purpose was to study the impact of FII on National stock exchange and to identify whether their importance in the development of Indian economy.

3.4 RESEARCH METHODOLGY: QUANTITATIVE AND QUALATATIVE

Research methods can be qualitative, quantitative or both (Schiffman and Kanuk, 2000). The selection of the particular research method depends on the kind of information required. Qualitative method collects, analyzes, and interprets data that cannot be meaningfully quantified, that is, summarized in the form of numbers. For this reason, qualitative method is sometimes referred to as soft study method. Any study using non-structured questioning or observation techniques can be labelled qualitative study. Qualitative method typically studies relatively few respondents or units. In other words, a study of a large, representative sample would normally not be called qualitative study method even if it used some non-structured questions or observations. The non-structured and small-sample features of qualitative study techniques have an important implication. They are intended to provide initial insights, ideas, or understanding about a problem, not to recommend a final course of action. Therefore, qualitative study techniques are most appropriate in situations calling for exploratory study. Quantitative study method, in contrast, is characterized by more structure and larger, more representative respondent samples. Consequently, the logical place for quantitative study techniques (usually in the form of large-scale questionnaire surveys or structured observations) is in conclusive studies. A primary role of qualitative study method is to generate hunches or hypotheses. In contrast, each of the situations under quantitative study calls for very specific data, capable of suggesting a final course of action (Parasuraman, et al. 2004).

The above description suggests us that qualitative research method is a soft approach in which collected and identified data or information cannot be meaningfully quantified and more importantly in this approach non-structured research is conducted; but so far as quantitative research method is concerned, in this approach structured study is conducted with approaching larger respondents and the collected data can be meaningfully quantified.

As the present research required both qualitative and quantifiable data to achieve the aims and objectives of the research, therefore both qualitative and quantitative research methods were applied in the research.

3.5 SAMPLING

Sampling is a simple and inexpensive way of data collection through questionnaire survey, where the data can be collected in the desired format. This is what sampling was adopted as method of data collection.

One of the most import parts of the questionnaires process is to determine the people (sample) that are approached for the questionnaires. There are various methods of selecting the sample and the most common are randomly and conveniently (Saunders et al, 2003). In the present research, the survey sample was selected conveniently. Sampling size of primary data was 20 questionnaires for various share market participants like brokers, mutual funds and financial institutions, FIIS and merchant banks and FII’s of the national stock exchange.

3.6 DATA COLLECTION

Research data can be collected either in the form of secondary or primary or both (Saunders et al, 2003). In this research both primary and secondary data were collected considering the nature of required information.

3.6.1 Secondary Data

Secondary Data usually factual information can be obtained through secondary data that have already been collected from other sources and are readily available from those sources (Parasuraman, et al. 2004). The definition and characteristics of secondary data presented above suggest us that secondary data are data that have already been collected for purpose other than the problem in hand. Before detailing as how and what secondary data were collected in this study, in would be worth to examine the advantages and disadvantages of such data.

Secondary data are easily accessible, relatively inexpensive, and quickly obtained. Some secondary data are available on topics where it would not be feasible for a firm to collect primary data. Although it is rare for secondary data to provide all the answers to a non-routine study problem, such data can be useful in a variety of ways (Kotabe, 2002). Secondary data can help: Identify the problem, better define the problem, develop an approach to the problem, formulate an appropriate research design (for example, by identifying the key variables), answer certain research questions and test some hypotheses and interpret primary data more insightfully. Because secondary data have been collected for purposes other than the problem at hand, their usefulness to the current problem may be limited in several important ways, including relevance and accuracy. The objectives, nature, and methods used to collect the secondary data may not be appropriate to the present situation. Also, secondary data may be lacking in accuracy, or they may not be completely current or dependable. Before using secondary data, it is important to evaluate them on these factors (Malhotra, 2004).

Although so many disadvantages are associated with the secondary data, but such data were found useful as identifying and defining the problem, and developing research objectives. The secondary data in this research was only in the form of qualitative, which helped not only in as identifying and defining the problem, and developing research objectives, but also in achieving the research objectives. The various sources of secondary data in this research were: books, journals, periodicals, newspapers and magazines and published reports on FIIs flow in Indian stock market.

3.6.2 Primary Data

Primary data is collected for the specific purpose of addressing the problem at hand. The collection of primary data involves various steps. Thus obtaining primary data can be expensive and time consuming (Malhotra, 2004). These suggest that primary data are those data that are collected for the particular purpose of research in hand. The disadvantage of collecting primary data is that it is lengthy and resource and time consuming process (in comparison of secondary data), but the advantage of primary data is that they are first hand information and comparatively more reliable (than secondary data).

Primary data can be collected from various sources and methods that are case studies, observation, questionnaire survey and interview (Saunders et al, 2003). In this research questionnaire survey method was applied in order to collect primary data.

Questionnaires can be structured or unstructured (Saunders et al, 2003). The nature of unstructured questionnaires is very vague, so in the present study structured questionnaires were conducted with the help of structured questionnaire. An appreciation of how the type of survey method influences questionnaire design can be obtained by considering how the questionnaire is administered under each method. In personal questionnaires, respondents see the questionnaire and interact face to face with the interviewer. Thus, lengthy, complex, and varied questions can be asked. In telephone questionnaires, the respondents interact with the interviewer, but they do not see the questionnaire. This limits the type of questions that can be asked to short and simple ones. Mail questionnaires are self-administered, so the questions must be simple and detailed instructions must be provided. Questionnaires designed for personal and telephone questionnaires should be written in a conversational style (Malhotra, 2004). Considering the above facts and features in mind, questionnaires in this study were conducted both through face-to-face and telephonic (in accordance with the convenience). The questionnaires were conducted with the help of a pre- designed questionnaire.

Designing questionnaires may appear to be simple, especially to those who have not designed one before. After all, you may think, once you have a clear notion of the information desired, it should be easy to formulate appropriate questions and arrange them in the form of an instrument (Parasuraman, 2004). In the present research questionnaire was designed considering the study aims and objectives.

As the research objectives required straightforward information therefore only structured questions were designed for the survey (questions with multiple options). The questionnaire consisted of 10 structured questions.

3.7 DATA ANALYSIS

Before analyzing a data set using sophisticated techniques, a researcher should get a feeling for what the data are like. The purpose of preliminary data analysis is to reveal features of the basic composition of the data collected. It can also provide useful insights pertaining to the research objectives and suggest meaningful approaches for further analysis of the data (Parasuraman, 2004). In accordance with the above prescription of data analysis, firstly all the collected data were coded and arranged in a systematic manner and then analysed in accordance with study objectives (comparing secondary and primary data).

CHAPTER4- ANLAYSIS AND PRESENTATION OF FINDINGS

4.1 INTRODUCTION

This section details about the analysis of the primary data collected which analysed with the help of secondary and primary data both.

4.2 FINDINGS AND ANALYSIS

FII flow in India and Government

The findings set up that FIIs can invest in India their own funds as well as invest on behalf of their overseas clients registered as such with SEBI. These client accounts that the FII manages are known as ‘sub-accounts’. A domestic portfolio manager can also register itself as an FII to manage the funds of sub-accounts. In recent years, the government has been making strong efforts to increase FII flows in India. However, far from being healthy for the economy, FII inflows have actually imposed certain burdens on the Indian economy. Understanding the determinants and effects of FII flows and devising appropriate regulation therefore constitute an important part of economic policy making in India. Though initially restricted to investing only in listed company stocks, FIIs are now allowed to invest in equity, bonds and derivative instruments in India subject to limits of foreign ownership for various sectors as well as ceilings on total investment per FII.

Evidently, in recent years, the government has been making strong efforts to increase FII flows in India, where understanding the determinants and effects of FII flows and devising appropriate regulation therefore constitute an important part of economic policy making in India. Based on this findings, it was tested in this research as how has the government in India has shown considerable degree of promptness recently to embark on potent policy initiatives aimed at increasing the flows of FII in India. The first hand data collected in the research confirms that undoubtedly on greater level, government in India ahs shown considerable degree of promptness recently to embark on potent policy initiatives aimed at increasing the flows of FII in India (see figure 4.1 below).

Figure 4.1: FII flow in India and Government

The data presented in the above table demonstrates that majority of respondents (75%) either ‘agree’ (40%) or ‘strongly agree’ (35%) regarding the fact that government in Indian has shown considerable degree of promptness recently to embark on potent policy initiatives aimed at increasing the flows of FII in India; whereas the remaining respondents (75%), either ‘disagree’ (20%) or ‘strongly disagree’ (5%) to this fact. Overall, these data conclude that undoubtedly on greater level, government in India ahs shown considerable degree of promptness recently to embark on potent policy initiatives aimed at increasing the flows of FII in India.

FII as driver of national stock exchange return in India

The findings set up that FII flows are routinely depicted as a major driver of national stock exchange return in the financial press. However, research seems to suggest they are more of an effect than a cause of national stock exchange performance. In the post-Asian crisis period, national stock exchange performance has been the sole driver of FII flows, though monthly data in the pre-Asian crisis period may suggest some reverse causality. Even though equity holdings of FIIs have received maximum attention from the press, researchers and policymakers alike, the debt holdings of FIIs are not wholly insignificant.

Evidently, FII flows are considered as a major driver of national stock exchange return. Based on this finding, it was tested in this research as whether FII is key driver of national stock exchange return in India. The first hand data collected in the research confirms that substantially FII is key driver of national stock exchange return in India (see figure 4.2 below).

Figure 4.2: FII as driver of national stock exchange return in India

The data presented in the above figure demonstrates that majority of respondents (75%) find that FII is key driver of national stock exchange return in India; whereas the remaining some 25% (5) respondents find that FII is not the key driver of national stock exchange return in India. Overall, these data conclude that substantially FII is key driver of national stock exchange return in India.

FII and sagging returns of the national stock exchange

The findings set up that the sales of Indian securities by FIIs are affected by returns but not purchases. FII flows are negatively related to lagged national stock exchange returns, suggesting negative feedback trading. There are, however, issues about the appropriateness of using monthly data in this analysis. In any case, given that there is a structural break; careful analysis of more recent data would be instructive in understanding the nature of the relationship and causality, if any, between these two variables.

Evidently, FII flows are negatively related to lagged national stock exchange returns, suggesting negative feedback trading. Based on these findings, it was tested in this research as flows of FII are akin to sagging returns of the national stock exchange, whether in negative or positive way. The first hand data collected in the research confirms that evidently the flows of FII are making to a negative way to sagging returns of the national stock exchange (see figure 4.3).

Figure 4.3 FII and sagging returns of the national stock exchange

The data presented in the above figure demonstrates that, for majority of respondents (85%) they find that flows of FII are akin to sagging returns of the national stock exchange ‘in negative way’; whereas for the remaining respondents (15%), they find that flows of FII are akin to sagging returns of the national stock exchange ‘in positive way’. Overall these data conclude that evidently the flows of FII are making to a negative way to sagging returns of the national stock exchange.

FII flows and national stock exchange volatility in India

The findings set up that the Asian crisis marked a regime shift in determining FII flows. India’s country risk rating did not seem to affect FII flows. There is questioned the diversification motive behind FII flows to India and report autocorrelation or inertia in FII flows. Both the national stock exchange as well as FII flows in India has high and related volatility. Finally, in their analysis of the effects of regulatory measures on FII flows, there is found that liberalizing policy changes have had expansionary effect on FII flows while restrictive measures aimed at giving regulators greater control over FII flows do not necessarily dampen them. Encouraging FII flows is that such flows can increase domestic investment without increasing foreign debt. They can raise stock prices, lower cost of equity and stimulate investment by Indian firms and lead to improvements in securities market design and corporate governance. In order to further stimulate FII flows, the expert group has suggested setting FII investment caps, if any, over and above the FDI sectoral limits. In cases where the limits have to be combined, they should be set at sufficiently high levels. This indicates that FII flows are contributing primarily to the amassing of huge foreign exchange reserves at the RBI rather than to real investment in the economy. Further, this accretion of reserves implies significant costs for the economy in terms of a fall in RBI profits through holding of lower yielding reserves, loss of seignorage revenue and the costs of sterilizing the inflows. In the presence of demand deficiency in the economy, the real effects of enhanced FII flows are likely to be far from positive. Thus FII flows should be viewed not in isolation but as part of an integrated policy package for all capital receipts keeping in mind their role in the overall macroeconomic structure.

Evidently, there is questioned the diversification motive behind FII flows to India and report autocorrelation or inertia in FII flows, however, both the national stock exchange as well as FII flows in India has high and related volatility, where FII flows are contributing primarily to the amassing of huge foreign exchange reserves at the RBI rather than to real investment in the economy. Based on this finding, it was tested in this research as how often it is two that FII flows and national stock exchange in India have a kind of volatility that is high and related. The first hand data collected in the research confirms that evidently the evidently FII flows and national stock exchange in India have a kind of volatility that is high and related (see figure 4.4).

Figure 4.4: FII flows and national stock exchange volatility in India

The data presented in the above figure demonstrates that for majority of respondents (85%) they find either ‘very often’ (45%) or ‘always’ (40%) that FII flows and national stock exchange in India have a kind of volatility that is high and related; whereas for the remaining respondents (15), they ‘sometimes’ find that FII flows and national stock exchange in India have a kind of volatility that is high and related. Overall, these data conclude that evidently FII flows and national stock exchange in India have a kind of volatility that is high and related.

Role of liberalisation in Indian national stock exchange

The findings set up that a grave balance of payments situation forced the policymakers to take a relook at allowing foreign capital Into the country and the year of 1991 marked the announcement of some fiscal disciplinary measures along with reforms on the external sector made, it possible for the foreign capital to reach the shores of the country. Along with liberalization and globalisation the market has also witnessed a growing trend of 'institutionalization'. More precisely the growing might of the institutional investors entities whose primary purpose is to invest their own assets or those entrusted to them by others and the most common among them are the mutual funds and portfolio investors. Today, giant institutions control huge sums of money, which they move continuously. In European and Japanese markets, institutions dominate virtually all trading. With the accelerating trends of reforms Indian national stock exchange will witness more and more of institutionalization and the increasing size of money under the control, this set of investors will play a major role in Indian equity markets. The importance of institutional investor’s particularly foreign investors is very much evident as one of the routine reasons offered by market. The increasing role of institutional investors has brought both quantitative and qualitative developments in the national stock exchange viz., expansion of securities business, increased depth and breadth of the market, and above all their dominant investment philosophy of emphasizing the fundamentals has rendered efficient pricing of the stocks.

Evidently, along with liberalization and globalization the market has also witnessed a growing trend of 'institutionalization', where the increasing role of institutional investors has brought both quantitative and qualitative developments in the national stock exchange. Furthermore, the growing might of the institutional investors entities whose primary purpose is to invest their own assets or those entrusted to them by others and the most common among them are the mutual funds and portfolio investors Based on this findings, it was tested in this research as how has been the role of liberalization (positive/negative) is Indian national stock exchange so far. The first hand data collected in the research confirms that generally the role of liberalization in national stock exchange has been sometimes positive, whereas negative at other times (see figure 4.5 below).

Figure 4.5: Role of liberalization is national stock exchange

The data presented in the above figure demonstrates that for a large part of the respondents (55%), the role of liberalization in Indian national stock exchange so far has been rather ‘positive’, whereas for a considerable part of the respondents (45%), the role of liberalization in national stock exchange has been rather ‘negative’. Overall, these data conclude that generally the role of liberalization in national stock exchange has been sometimes positive, whereas negative at other times.

FII effect on national stock exchange

The findings set up that since it is not statutorily binding on Flls to make public, the companies in which they are investing in, there is no publicly available information on this aspect. However, the overall investment that can be made by all Flls in any company's equity is monitored by Reserve Bank of India, it gives a caution notice. Subsequently, all purchases have to be done by prior approval of Reserve Bank of India. From such monitoring reports it can be gauged that the Flls are market or not. Here, one has to note that most stocks that figure in institutional investors' portfolios are more or less those securities that comprise the nifty or Sensex indices hence, co-movements between index and the institutional investments is likely. The Indian national stock exchanges have really come of age there were so many developments over the years that make the markets on par with the developed markets. The important feature of developed markets is the growing clout of institutional investors and this paper sets out to find whether our markets have also being dominated by institutional investors. The regression results show that the combined might of the FIIs and mutual funds are a potent force, and they in fact direction can forecast market direction using the direction of the flow of funds from FIIs and mutual funds, the Granger causality test has showed that the mutual funds in fact lead the market rise or fall and FIIs follow suit. This may actually raise questions on the market efficiency but on the contrary, markets become more efficient with the growing presence of institutional investors who predominantly go by fundamentals. Noise trading on the part of institutional investors will be less in Indian context since all their trades are delivery based only.

Evidently, the national stock exchanges have really come of age there were so many developments over the years that make the markets on par with the developed markets, where the combined might of the FIIs and mutual funds are a potent force, and they in fact direction can forecast market direction using the direction of the flow of funds from FIIs and mutual funds, and the mutual funds in fact lead the market rise or fall and FIIs follow suit. Based on these findings, it was tested in this research as how has been the role of FII (positive/negative) in national stock exchange so far. The first hand data collected in the research confirms that generally the role of foreign FII in national stock exchange so far as been both positive and negative in somewhat equal degree

The data presented demonstrates that for half of the total respondents (50%), the role of foreign FII in national stock exchange so far as has been rather ‘positive’, while for the remaining half respondents (50%), the role of foreign FII in Indian national stock exchange so far as been rather ‘negative’. Overall, these data conclude that generally the role of foreign FII in national stock exchange so far as been both positive and negative in somewhat equal degree.

FIIs and domestic investors in national stock exchange

The findings set up that the relationship between national stock exchange volatility and liberalization has also been examined extensively. The empirical result revealed that most countries that have experienced liberalization have had decreases in volatility. However FII has a positive influence on the volatility of the exchange rate, meaning that foreign investment’s inward remittances may increase volatility in exchange rate, while the outward remittances may not. Furthermore, foreign investment may only affect a small fraction of national stock exchange volatility. Finally, stock returns are affected only by non-fundamental factors before the inflow of foreign investment. Nonetheless, after the inflow of foreign investment, both fundamental and non-fundamental factors may affect stock returns. The functioning of the exit market and the opportunities to divest investments are vital for the venture capitalist ability to realize profits and focus on its functional core area of management and monitoring of small ventures. Presence of a foreign venture capital investor and indirect ties to foreign venture capitals through syndication networks of own domestic investors help mitigate these problems by increasing the awareness among potential investors about the venture and alleviating the problems of asymmetric information and illegitimacy of foreign investment targets.

Evidently, FII has a positive influence on the volatility of the exchange rate, meaning that foreign investment’s inward remittances may increase volatility in exchange rate, however, presence of a foreign venture capital investor and indirect ties to foreign venture capitals through syndication networks of own domestic investors help mitigate the problems. Based on this finding, it was tested in this research as how often do you find that foreign FIIs have restricted the investors in India to have access in national stock exchange. The first hand data collected in the research confirms that in most cases, foreign FIIs have restricted the investors in India to have access in national stock exchange (see figure 4.7 below).

Figure 4.7: FIIs and domestic investors in national stock exchange

The data presented in the above figure demonstrates that for majority of respondents (75%), foreign FIIs either ‘very often’ or ‘always’ (20%) have restricted the investors in India to have access in national stock exchange; whereas for the remaining respondents (25%), foreign FIIs ‘sometimes’ have restricted the investors in India to have access in national stock exchange. Overall, these data conclude that in most cases, foreign FIIs have restricted the investors in India to have access in national stock exchange.

Regulatory system in India and FII risk

The findings set up that a foreign venture capital investor may function as a mediating channel between the venture and the potential new investors. While the mass media may transmit some beneficial information on a specific venture, the existing social and institutional ties of a foreign venture capitalist are more likely to be effective when targeted towards prospective investors. Although these investors could be contacted also across borders, the relational embeddedness and proximity increases the effectiveness of knowledge transfer. The foreign investor can utilize its existing contacts to promote the venture and increase the likelihood of attracting new, foreign investors. Negative investment might possibly disturb the long-term relationship between FII and other variables such as equity returns, inflation, and so on. There is a regime shift in the determinants of FII following the Asian financial crisis and found that in the pre–Asian crisis period, any change in FII had a positive impact on equity returns. But it was found that in the post–Asian crisis period, a reverse relationship has been the case, namely, that change in FII is mainly due to change in equity returns. This is a fact that needs to be taken into account in any empirical investigation of FII. Investments, either domestic or foreign, depend heavily on risk factors. Hence, while studying the behaviour of FII, it is important to consider the risk variable. Further, realized risk can be divided into ex-ante and unexpected risk. Ex-ante risk is an observed component and is negatively related to FII. But the relationship between unexpected risk and FII is obscure. Therefore, while examining the impact of risk on FII; one needs to separate the unobserved component from the realized risk.

Evidently, there is a regime shift in the determinants of FII following the Asian financial crisis and found that in the pre–Asian crisis period, any change in FII had a positive impact on equity returns, where realized risk can be divided into ex-ante and unexpected risk and ex-ante risk is an observed component and is negatively related to FII. But the relationship between unexpected risk and FII is obscure. Based on this findings, it was tested in this research as how effective is regulatory system in India to deal with FII risk in national stock exchange. The first hand data collected in the research confirms that regulatory system in India is generally not effective to deal with foreign FIIs risk in national stock exchange (see figure 4.8 below).

Figure 4.8: Regulatory system in India and FII risk

The data presented in the above figure demonstrates that for majority of respondents (60%), regulatory system in India is ‘not effective’ to deal with foreign FIIs risk in national stock exchange; while for the remaining respondents (40%), regulatory system in India is either ‘reasonably effective’ (25%) or ‘highly effective’ (15%) to deal with foreign FII risk in national stock exchange. Overall, these data conclude that regulatory system in India is generally not effective to deal with foreign FIIs risk in national stock exchange.

FII flow and future of national stock exchange in India

The findings set up that one of the outstanding features of globalization in the financial services industry is the increased access provided to non-local investors in several major national stock exchanges of the world. Increasingly, national stock exchanges from emerging markets permit institutional investors to trade in their domestic markets. This opening up of capital markets in emerging market countries has been perceived as beneficial by some researchers while others are concerned about possible adverse consequences such as contagion. The perceived advantages of base-broadening arise from an increase in the investor base and the consequent reduction in risk premium due to risk sharing. Other researchers and policy makers are more concerned about the attendant risks associated with the trading activities of foreign investors.They are particularly concerned about the herding behaviour of foreign institutions and the potential destabilization of emerging national stock exchanges. FIIs in India, invest in large, liquid companies which enable them to exit their positions quickly at relatively lower cost and also that the foreign institutional owners have a larger impact than foreign corporate owners when performance is measured using national stock exchange valuation criterion. Given that India is one of the fastest growing economies in South Asia, promising a considerable rate of growth, it would not be a surprise to see increased FII flows to India in the future.

Evidently, FIIs in India, invest in large, liquid companies which enable them to exit their positions quickly at relatively lower cost, where India is one of the fastest growing economies in South Asia, promising a considerable rate of growth, it would not be a surprise to see increased FII flows to India in the future. Based on this finding, it was tested in this research as how prospective is the future of national stock exchange in India in the light of FIIs flow. The first hand data collected in the research confirms that the future of national stock exchange in India is usually very prospective in the light of foreign FIIs flow (see figure 4.9 below).

Figure 4.9: FII flow and future of national stock exchange in India

The data presented in the above figure demonstrates that for majority of respondents (65%), the future of national stock exchange in India is ‘very prospective’ in the light of foreign FIIs flow; while for the remaining respondents (35%), the future of national stock exchange in India is either ‘simply prospective’ (25%) or ‘not prospective’ (10%) in the light of foreign FIIs flow. Overall, these data conclude that the future of national stock exchange in India is usually very prospective in the light of foreign FIIs flow.

Liberalization considering national stock exchange future prosperity

The findings set up that the capital market reforms like improved market transparency, automation, dematerialization and regulations on reporting and disclosure standards were initiated because of the presence of the FIIs. But FII flows can be considered both as the cause and the effect of capital market reforms. The market reforms were initiated because of the presence of FIIs and this in turn has lead to increased flows. Portfolio investments supplement foreign exchange availability and domestic savings but are most often not project specific. FPI, are welcomed by India since these are non-debt creating. Portfolio investments have some macroeconomic implications. While contributing to build-up of foreign exchange reserves, portfolio investments would influence the exchange rate and could lead to artificial appreciation of local currency. This could hurt competitiveness. Portfolio investments are amenable to sudden withdrawals and therefore these have the potential for destabilising an economy. Attracting foreign capital appears to be the main reason for opening up of the national stock exchanges for FIIs. The Government of India issued the relevant Guidelines for FII investment. Only a few days prior to this, however it is suggested that India would have to wait for some years before the expected large FIIs materialize with more pace of liberalization.

Evidently, FII flows can be considered both as the cause and the effect of capital market reforms, and the market reforms were initiated because of the presence of FIIs and this in turn has lead to increased flows, however, it is suggested that India would have to wait for some years before the expected large FIIs materialize with more pace of liberalization. Based on this finding, it was tested in this research as how is the current pace of liberalization considering Indian national stock exchange future prosperity. The first hand data collected in the research confirms that on greater level the current pace of liberalization is not adequate considering the future prosperity of national stock exchange (see figure 4.10 below).

Figure 4.10: Liberalization considering Indian national stock exchange future prosperity

The data presented in the above figure demonstrates that for majority of respondents (80%), the current pace of liberalization is either ‘adequate’ (25%) or ‘not adequate’ (55%) considering the future prosperity of Indian national stock exchange; while for the remaining respondents (20%) the current pace of liberalization is ‘more than adequate’ considering future prosperity of Indian national stock exchange. Overall, these data conclude that on greater level the current pace of liberalization is not adequate considering the future prosperity of Indian national stock exchange.

CHAPTER 5-CONCLUSION AND RECOMMENDATIONS

5.1 INTERPRETATION OF THE FINDINGS

The government has been making strong efforts to increase FII flows in India, where understanding the determinants and effects of FII flows and devising appropriate regulation therefore constitute an important part of economic policy making in India. Based on this findings, it was tested in this research as how has the government in India has shown considerable degree of promptness recently to embark on potent policy initiatives aimed at increasing the flows of FII in India. The first hand data collected in the research confirms that undoubtedly on greater level, government in India ahs shown considerable degree of promptness recently to embark on potent policy initiatives aimed at increasing the flows of FII in India. Furthermore, FII flows are considered as a major driver of national stock exchange return. Based on this finding, it was tested in this research as whether FII is key driver of national stock exchange return in India. The first hand data collected in the research confirms that substantially FII is key driver of national stock exchange return in India.

FII flows are negatively related to lagged national stock exchange returns, suggesting negative feedback trading. Based on this finding, it was tested in this research as flows of FII are akin to sagging returns of the national stock exchange, whether in negative or positive way. The first hand data collected in the research confirms that evidently the flows of FII are making to a negative way to sagging returns of the national stock exchange. Furthermore, there is questioned the diversification motive behind FII flows to India and report autocorrelation or inertia in FII flows, however, both the national stock exchange as well as FII flows in India has high and related volatility, where FII flows are contributing primarily to the amassing of huge foreign exchange reserves at the RBI rather than to real investment in the economy. Based on this finding, it was tested in this research as how often it is two that FII flows and national stock exchange in India have a kind of volatility that is high and related. The first hand data collected in the research confirms that evidently the evidently FII flows and national stock exchange in India have a kind of volatility that is high and related.

Along with liberalization and globalisation the market has also witnessed a growing trend of 'institutionalization', where the increasing role of institutional investors has brought both quantitative and qualitative developments in the national stock exchange. Furthermore, the growing might of the institutional investors entities whose primary purpose is to invest their own assets or those entrusted to them by others and the most common among them are the mutual funds and portfolio investors Based on this findings, it was tested in this research as how has been the role of liberalization (positive/negative) is national stock exchange so far. The first hand data collected in the research confirms that generally the role of liberalization in national stock exchange has been sometimes positive, whereas negative at other times. Furthermore, the Indian national stock exchanges have really come of age there were so many developments over the years that make the markets on par with the developed markets, where the combined might of the FIIs and mutual funds are a potent force, and they in fact direction can forecast market direction using the direction of the flow of funds from FIIs and mutual funds, and the mutual funds in fact lead the market rise or fall and FIIs follow suit. Based on this finding, it was tested in this research as how has been the role of FII (positive/negative) in national stock exchange so far. The first hand data collected in the research confirms that generally the role of foreign FII in national stock exchange so far as been both positive and negative in somewhat equal degree.

FII has a positive influence on the volatility of the exchange rate, meaning that foreign investment’s inward remittances may increase volatility in exchange rate, however, presence of a foreign venture capital investor and indirect ties to foreign venture capitals through syndication networks of own domestic investors help mitigate the problems. Based on these findings, it was tested in this research as how often do you find that foreign FIIs have restricted the investors in India to have access in national stock exchange. The first hand data collected in the research confirms that in most cases, foreign FIIs have restricted the investors in India to have access in national stock exchange. Furthermore, there is a regime shift in the determinants of FII following the Asian financial crisis and found that in the pre–Asian crisis period, any change in FII had a positive impact on equity returns, where realized risk can be divided into ex-ante and unexpected risk and ex-ante risk is an observed component and is negatively related to FII. But the relationship between unexpected risk and FII is obscure. Based on this findings, it was tested in this research as how effective is regulatory system in India to deal with FII risk in national stock exchange. The first hand data collected in the research confirms that regulatory system in India is generally not effective to deal with foreign FIIs risk in national stock exchange.

FIIs in India, invest in large, liquid companies which enable them to exit their positions quickly at relatively lower cost, where India is one of the fastest growing economies in South Asia, promising a considerable rate of growth, it would not be a surprise to see increased FII flows to India in the future. Based on this finding, it was tested in this research as how prospective is the future of national stock exchange in India in the light of FIIs flow. The first hand data collected in the research confirms that the future of national stock exchange in India is usually very prospective in the light of foreign FIIs flow. Furthermore, FII flows can be considered both as the cause and the effect of capital market reforms, and the market reforms were initiated because of the presence of FIIs and this in turn has lead to increased flows, however, it is suggested that India would have to wait for some years before the expected large FIIs materialize with more pace of liberalization. Based on this finding, it was tested in this research as how is the current pace of liberalization considering national stock exchange future prosperity. The first hand data collected in the research confirms that on greater level the current pace of liberalization is not adequate considering the future prosperity of national stock exchange.

5.2 RECOMMENDATIONS FOR FURTHER RESEARCH

Investments of portfolio cause risk for FIIs, offering an opportunity to have a share in the benefits of growth in developing nations that are likely to grow by a greater pace. Investment in various emerging markets may give more return on investments for funds related to pension as also investors with private interests hailing from developed nations. So far as developing economies are concerned, FIIs in portfolio equity may have distinct implications and characteristics bearing little resemblance with those of FDI (World Bank, 1997). A research is recommended to study comparative implications of FIIs in portfolio equity and that of FDI in relation to Indian National Stock Exchange.

5.3LIMITATIONS

Due to limited time and resources, the researcher had to downsize my plan on various fronts. Firstly, getting an appointment with the respondents was not easy as in some cases they had tight schedule in their professional activities, whereas some were found unwilling to respond the questionnaire. Secondly, due to provided limited time the researcher could not conduct all the questionnaires face-to-face or personally, and thus in many cases he had to satisfied with telephonic conversation.

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Appendices

Appendix 1 QUESTIONNAIRE

1. How do you agree that government in India has shown considerable degree of promptness recently to embark on potent policy initiatives aimed at increasing the flows of FII in India?

Strongly Agree

Disagree Strongly disagree

2. Do you find that FII is key driver of stock market return in India?

Yes No

3. Flows of FII are akin to sagging returns of the stock market?

In positive way In negative way

4. How often it is found that FII flows and stock market in India have a kind of volatility that is high and related….?

Always Very often

Sometimes Never

5. The role of liberatisation is Indian stock market so far has been….?

Positive Negative

6. The role of foreign FII in Indian stock market so far has been……..?

Positive Negative

7. Do you believe that foreign FII have restricted the investors in India to have access in stock market?

Always Very often

Sometimes Never

8. Do you find the regulatory system in India is competent enough to deal with foreign FII risk in stock market?

Highly effective Reasonably effective

Not effective

9. In the light of foreign FIIs flow, how do you see the future of stock market in India??

Very prospective Simply prospective

Not prospective

10. Do you find that more liberalization is needed for Indian stock market prosperity

More than adequate Adequate

Not adequate

Thank you,

Appendix 2 Interview