Macroeconomics

Project Report
On
Trends in FII and Rate of
Exchange
(2004-05 to 2013-14)

Submitted To:

Submitted By:

Prof. Jagdish Shettigar

(15DM131)

Saloni Ramsisaria
Sankalp Jain (15DM133)
Satyanarain Mishra

(15DM135)

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Shubham Kogta
(15DM146)
Shubham Saxena
(15DM147)

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ACKNOWLEDGEMENT
All the members of our Macroeconomics project group
take this opportunity to thanks our Honourable Director,
Dr. H. Chaturvedi, for providing a healthy college
environment, which helped in the successful
completion of the task. We also thank, Prof. Jagdish
Shettigar and all the faculty members, teaching and
non teaching for helping us during the Project.

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CONTENT

Acknowledgement
1. Introduction

2
4

2. Role of FIIs in India

3. Government Policies

4. Factors Contributing to the FII flows in India

12
5. Trends in FII and interest rate
14
6. Relationship between Exchange Rate
16
and FII
7. Road Ahead
17
8. Exhibits

18

References

21

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Introduction
A FII is an investor or investment fund that is from or registered
in a country outside of the one in which it is currently investing.
Institutional investors include hedge funds, insurance
companies, pension funds and mutual funds. Foreign
institutional investors (FIIs) are those institutional investors
which invest in the assets belonging to a different country other
than that where these organizations are based. Foreign
institutional investors play a very important role in any
economy. These are the big companies such as investment
banks, mutual funds etc., who invest considerable amount of
money in the Indian markets. With the buying of securities by
these big players, markets trend to move upward and viceversa. They exert strong influence on the total inflows coming
into the economy.
FII is defined as an institution organized outside of India for the
purpose of making investments into the Indian securities
market under the regulations prescribed by SEBI. FIIs include
overseas pension funds, mutual funds, investment trust, asset
management company, nominee company, bank, institutional
portfolio manager, university funds, endowments, foundations,
charitable trusts, charitable societies, a trustee or power of
attorney holder incorporated or established outside India
proposing to make proprietary investments or investments on
behalf of a broad based fund. FIIs can invest 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 foreign institutional investor means an entity
established or incorporated outside India which proposes to
make investment in India.
Positive tidings about the Indian economy combined with a fast
growing market have made India an attractive destination for
foreign institutional investors. FII is defined as an institution
organized outside of India for the purpose of making
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investments into the Indian securities market under the

regulations prescribed by SEBI.

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Role of FIIs in India

Foreign portfolio inflows through FIIs, in India, are important
from the policy perspective, especially when the country has
emerged as one of the most attractive investment destinations
in Asia. In this paper an effort has been made to develop an
understanding of the investment decisions, trading strategies
and behaviour of the FIIs in the Indian equity market.
A general perception about the FIIs is that they are speculators
and their investment is motivated by short- term gains. The FIIs
in pursuit of short- term gains adopt short- term trading
strategies such as positive feedback trading and herding. Such
behavioural biases of FIIs, it is believed, may lead to price
overreaction and contribute to the creation or exacerbation of a
financial crisis.
Entry Options for FII
A foreign company planning to set up business operations in
India has the following options: Incorporated Entity i.e. by
incorporating a company under the Companies Act, 1956,
through Joint Ventures; or Wholly Owned Subsidiaries. Foreign
equity in such Indian companies can be up to 100% depending
on the requirements of the investor, subject to equity caps in
respect of the area of activities under the Foreign Direct
Investment (FDI) policy.
Institutional investors will have a lot of influence in the
management of corporations because they will be entitled to
exercise the voting rights in a company. They can actively
engage in corporate governance. Furthermore, because
institutional investors have the freedom to buy and sell shares,
they can play a large part in which companies stay solvent, and
which go under influencing the conduct of listed companies,
and providing them with capital are all part of the job of
management. One of the most important features of the
development of stock market in
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India in the last 20 years has been the growing participation of

FIIs. Since September, 1992 when FIIs were allowed to invest in
India, the no. of FIIs has grown over a period of time. FIIs
contribute to the external exchange inflow as the funds from
multilateral finance institutions and FDI (External direct
investment) are inadequate.
Following are the some compensation of FIIs:

It lowers cost of capital, access to cheap global credit.

It supplements domestic savings and investments.

It leads to higher asset prices in the Indian arcade.

And has also led to considerable amount of reforms in

capital arcade and financial sector.

Positive contribution of FIIs has been in improving the

stock exchange infrastructure.

FIIs play an important role in bringing n funds needed by

the equity arcade.

FIIs as professional bodies of asset managers and financial

analysts enhance competition and efficiency of financial
markets.

By increasing the availability of riskier long term capital

for projects, and increasing firms incentives to provide more
information about their operations, FIIs can help in the process
of economic development.

FII inflows help in financial innovation and development of

hedging instruments. Also, it not only enhances competition in
financial markets, but also improves the alignment of asset
prices to fundamentals.

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Government Policies
Various developments and changes have been made to the
policies of foreign investments be through FDIs or FIIs. A few
changes prior to the 2008-10 world economic recession and
after that have been made to cope and control the economy. A
few of them are as:
I. Permission for short selling of Equity Shares by SEBI
registered FIIs
SEBI registered FIIs / subaccounts of FIIs were permitted to
buy / sell equity shares / debentures of Indian companies.
However, they were not allowed to engage in short selling and
were required to take delivery of securities purchased and give
delivery of securities sold.
After a due consultation process, it was decided to permit FIIs
registered with SEBI and sub-accounts of FIIs to short sell, lend
and borrow equity shares of Indian companies, subject to such
conditions as may be prescribed in that behalf by the Reserve
Bank and the SEBI / other regulatory agencies from time to
time.
Accordingly, RBI, through a circular dated 31December, 2007,
permitted the above subject to the following conditions:
(i)
The FII participation in short selling as well as borrowing /
lending of equity shares will be subject to the current FDI policy
and short selling of equity shares by FIIs would not be
permitted for equity shares which are in the ban list and / or
caution list of Reserve Bank.
(ii) Borrowing of equity shares by FIIs would only be for the
purpose of delivery into short sale.
(iii) The margin / collateral would be maintained by FIIs only in
the form of cash. No interest would be paid to the FII on such
margin/collateral. RBI further provided that the designated
custodian banks should separately report all transactions
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pertaining to short selling of equity shares and lending and

borrowing of equity shares by FIIs in their daily reporting with a
suitable remark (short sold / lent / borrowed equity shares) for
the purpose of monitoring by the Reserve Bank. SEBI also
issued an amendment to the FII Regulations permitting FIIs to
short sell and lend and borrow securities.
II. FII investments in Debt Securities
SEBI vide its circular dated January 19, 2007 announced the
increase in the cumulative debt investment limit available for
investment by FIIs/ Sub Accounts in Government Securities/ TBills from US $2 billion to US $2.6 billion. This limits was further
enhanced to US $3.2 billion vide SEBI circular dated January 31,
2008.It was noticed that there was no uniformity among
custodians with respect to considering investments by FIIs in
debt
Oriented mutual fund units either as debt or equity. In
consultation with RBI, SEBI decided that investments by FIIs/
Sub Accounts in debt oriented mutual fund units (including
units of money market and liquid funds) should henceforth be
considered as corporate debt investments and reckoned within
the stipulated limit of US $1.5 billion, earmarked for FII/
Sub Account investments in corporate debt. In view of the
above, the following was made applicable with immediate
effect:
1. Henceforth, there would be no demarcation between 100%
debt and normal 70:30 FIIs/ Sub Accounts for the purposes of
allocation of debt investment limits. The individual limits
allocated to the 100% debt FIIs/ Sub Accounts stand cancelled.
2. The allocation of unutilized/ unallocated limits for
investments in Government Securities/ T-Bills would be on firstcome-first-serve basis. The allocation would be valid for a
period of 15 days from the date of the allocation letter, on the
expiry of which the unutilized limits would lapse.
3. As mentioned above, the investments by FIIs/ Sub Accounts
in debt oriented mutual fund schemes should now be reckoned
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as investments in corporate debt. On re-calculating investment

figures for investments by FIIs/ Sub Accounts in corporate debt,
by including their investments in units of debt oriented mutual
funds, it is seen that the corporate debt investments exceed
the permissible limit of US $1.5 billion. Thus, in order to
conform to the stated limit, there should be no further
investment, or rollover, of existing position in corporate debt,
by both 100% debt and normal 70:30 FIIs, till the holdings fall
within the stipulated limit of US $1.5 billion.
III. Foreign investment in Commodity Exchanges
Government of India decided to allow foreign investment in
Commodity Exchanges subject to the following conditions:
i.
There would be a composite ceiling of 49% Foreign
Investment, with a FDI limit of 26% and an FII limit of 23%.
ii.
FDI will be allowed with specific approval of the
Government.
iii. The FII purchases in equity of Commodity Exchanges will
be restricted only to the secondary markets.
iv. Foreign Investment in Commodity Exchanges would also
be subject to compliance with the regulations issued, in this
regard, by the Forward Market Commission. Accordingly, a
necessary circular was issued by RBI on 28th April, 2008.
IV. Foreign investment in Credit Information Companies
The Government decided to allow foreign investment in Credit
Information Companies in compliance with the Credit
Information Companies (Regulations) Act 2005 and subject to
the following:
i) The aggregate Foreign Investment in Credit Information
Companies would be 49%.
ii) Foreign Investment upto 49% would be allowed only with the
prior approval of FIPB and regulatory clearance from RBI.
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iii) Investment by SEBI Registered FIIs would be permitted only

through purchases in the secondary market to an extent of
24%.
iv) Investment by SEBI Registered FIIs would be within the
overall limit of 49% for Foreign Investment. Accordingly, a
necessary circular was issued by RBI on 28th April, 2008.

V. FII investments in Debt Securities

The Government reviewed the External Commercial Borrowing
policy and increased the cumulative debt investment limits
from US $3.2 billion to US $5 billion and US $1.5 billion to US $3
billion for FII investments in Government Securities and
Corporate Debt, respectively. Accordingly, SEBI issued a
necessary circular giving effect to this decision
on June 6, 2008.It was further provided that the enhanced limits
should be allocated among the FIIs on a first come first served
basis in terms of SEBIs earlier circular dated January 31, 2008,
subject to a ceiling of US $200 million per registered entity.
The government has undertaken various liberal policy decisions
to make the whole process of foreign investment in India hassle
free. Some of the foreign investment policies include:
1. The list of industries that are eligible for automatic approval
of foreign investment has been expanded by the Ministry of
industry.
2. The upper limit of the rate of foreign investment in India has
been raised to 74% from the earlier 51%; in some cases this
has been increased to 100%.

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3. Indian companies will no longer need prior clearance from

the reserve Bank of India, RBI for inward remittance of foreign
exchange or for issuing of shares to foreign investors.
4. The exchange control regulations has been amended by the
government.
5. The ban against the use of foreign brand names/trademarks
has been removed.
6. The corporate rate of corporate tax on foreign companies
has been reduced from 65% to 55% by the government in the
annual budget of 1994-95.
7. The government reduced long term capital gains rate for
overseas companies to 20%
8. Under the Indian Income Tax Act, export earnings are
exempted from corporate income tax for both overseas and
domestic firms.
9. 100% inflow of foreign investment is permitted in strategic
sectors such as roads, ports, tunnels, highways and harbors on
the condition that the total investment in any of the sector
should not exceed ` 1500 crore.
10. Any increase within the prescribed limit does not require
permission from the foreign investment promotion board
Relaxation in policies
The government has relaxed certain existing laws and made
changes in some and in some cases enacted new laws to
ensure better opportunities for foreign investment in India. A
five year tax holiday has been extended to enterprises that are
working in the development of infrastructural facilities. Foreign
companies are allowed to start multimodal transport services in
India even though they do not have a registered office in India.
RBI permits 100% foreign investment in the construction of
roads and bridges. Other measures include expansion of freely
importable items on the open general license list to include
certain consumer goods and enhancement of the scope of
special import license
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Recent Developments
Recently government has allowed FIIs in:
banking up to 74%
defence up to 49% under direct route, more than this
through FIPB
plantation up to 100%
aviation up to 49% in regional air transport service

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Factors contributing to the FII flows to

India
Regulation and Trading Efficiencies: Indian stock markets
have been well regulated by the stock exchanges, SEBI and RBI
leading to high levels of efficiency in trading, settlements and
transparent dealings enhancing the confidence level of FIIs in
increasing allocations to India.
New Issuance: We have witnessed extremely high quality
issuance during the year from companies such as NTPC, ONGC
and TCS leading to strong FII participation with successful new
issuance of over $ nine billion, yet another record for the year.
Attractive Markets: Indian equity markets continue to be
attractive to foreign investors with expected earnings growth
of over 13 per cent compared with negative growth expected
among competing countries in the region such as Taiwan and
Korea. Indian blue chips are seen to have high quality of
balance sheets with net debt to equity of the top 30 companies
being negative, with net cash on the balance sheets. However
earnings growth is expected to be lower than last year and
upside in stock prices will be subject to sentiments in the
global markets and foreign flows to emerging markets.
However, high quality new issuance from PSUs and other large
corporate will continue to see good demand from FIIs. However
domestic mutual funds have been net sellers of equities during
2004 with risk aversion still prevalent among local investors
after seeing several short periods of high volatility. With the
booming stock markets presently catching the headlines in
local press, this trend will hopefully reverse during 2005.
Outsourcing: The rhetoric over outsourcing of jobs to India
has died down after the US elections and demand will soar for
Indian BPO and software services companies. However Indian
software companies will need to enhance margins by going up
the value chain to high level consulting and scaling up the
project sizes. Significant outsourcing opportunities will also
open up in textiles and drugs with dismantling of quotas for

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textiles and introduction of product patent regime for

pharmaceuticals.
Infrastructure: Woefully inadequate infrastructure is the
biggest bottleneck for the growth and profitability of Indian
corporations. The administration needs to move much faster in
privatisation of Projects in the areas of power, transportation,
ports, airports and other urban infrastructure to enhance
competitiveness. This is particularly relevant due to the fact
that competing countries in Asia Pacific and China have moved
at a much faster pace during the last five years and have in
place a first world infrastructure.
Capex Cycle: With strong balance sheets, high liquidity in the
banking system, supportive capital markets and growing
demand for goods and services we expect to see a strong
wave of capital expenditure cycle during the year leading to
tremendous opportunities for Indian equities.
Dollar Weakness: Analysts continue to look for a weak US
dollar with the US twin deficits (budget and trade deficits)
unlikely to be resolved anytime soon. Studies have shown that
flows into emerging markets rise significantly during times of
dollar weakness and India will continue to be a beneficiary of
this trend. Indian Rupee is expected to strengthen further
during 2005 which will be particularly favourable for domestic
demand oriented businesses such as banks and automobiles.
Rising Commodity Prices: Demand supply dynamics in both
crude and metals call for higher prices during 2005 with
increasing Chinese demand and economic recovery in Japan.
This has inflationary implications for India going forward,
though it will be a boon for commodity counters.
Consolidation: FII activity has been focused on large cap
companies due to liquidity reasons, and hence several high
quality mid cap companies trade at a valuation discount due to
lack of investor demand. We expect to see significant merger
activity among mid-caps which will enable them to gain better
valuations under the institutional radar screen, in addition to
consolidation efficiencies. While China attracts significantly
higher FDI, India with its highly developed capital markets will
be a beneficiary of FII flows at increasing pace each year. To
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summarise, Indian markets have successfully absorbed the

gains seen during 2003 and consolidated well during 2004 with
a modest gain and look set to outperform the global financial
markets during 2005.

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Trends in FII and Interest Rates

Trend in Interest Rates
In India, interest rate decisions are taken by the Reserve Bank
of Indias Central Board of Directors. The official interest rate is
the benchmark repurchase rate. In 2014, the primary objective
of RBI monetary policy became price stability, giving less
importance to governments borrowing, the stability of the
rupee exchange rate and the need to protect exports. In
February 2015, the government and the central bank agreed to
set a consumer inflation target of 4 percent, with a band of plus
or minus 2 percentage points, from the financial year ending in
March 2017.
Over the last ten years, the interest rates have constantly
increased. Though there was a drop in interest rate during 2009
10 due to unfavourable economic situation. Also, the rates
dropped in mid 2013, due to slowdown, however recovered. But
year 2014 15 faced slowdown and high inflation leading to the
fall in foreign investments and therefore, the interest rate in
2014 was 7.75%. (Exhibit 1)
Trend in FIIs
The FII during past one decade have been fluctuating. FII
recovered well from the economic slowdown of year 2008 09
but then kept on fluctuating. In current year, FII has again fallen
down to Rs 4,002.08 crores so far. (Exhibit 2)
However, there are positive hopes in the FII with the opening up
of new sectors. Also, the revision of caps under certain sector
are hoped to have a positive impact on the FII.
The sector wise FII investment for the last 12 years shows that
consumer goods contributes maximum to the FII in the country
(exhibit 3) whereas there is almost negligible contribution from
textile industries to the FII.
Trends in FII and Interest Rate
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There is a direct relationship between the interest rates and FII

(Exhibit 4). During last 13 years, it is observed that the fall in
interest rate have simultaneous fall in FII and vice a versa.
Although the effect of change in the interest rate does not
affect the FII investment at the same time the affect is gradual
and slow. The real interest rate effects the personal interest of
the investors as it is connected with their economic welfare and
there return on investment thats why for an increase in
interest rate theres an increase in investment as they are
directly related to each other.

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FII and Exchange Rate

Though the FII have great impact on the real economy of the
country and its factors such as exchange rate and foreign
investment, the vice a versa is also true. Exchange rate has
great impact on the foreign investment and foreign reserves.
With more FII, the imports increase, thus resulting in
appreciation of rupee compared to foreign currency. However,
with decrease in imports, the rupee depreciates. Also, like FII
affects exchange rate, similarly, exchange rate affects FII. If the
value of rupee as compared to, say, 1 USD is low (say 1 USD =
Rs 70), there will be huge inflows of foreign investment, but if
the case is opposite, that is, if value of rupee is high (say 1 USD
= Rs 65), the foreign investment will reduce as mostly the
foreign currency flows in the market through trade.
Exhibit 5 shows the current exchange rate, and Exhibit 6 shows
the current FII, both on daily basis. Here we see that the
fluctuation in exchange rate have affect on FII, though the
affect is slow but is visible.
Say for example, on 9 November 2015 when compared to 6
November 2015, the value of rupee appreciated, and the FII
inflow during the same period fell by 705.69 points.
Therefore, exchange rate and FII are closely related and have
impact on each other, that is, both plays as a factor
determining the other.

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Road Ahead
Backed by considerable support from the Centre, the FII sector
is set to prosper in India's economy. The present looks
encouraging. Foreign investors' net inflows reached Rs 7,12,974
crore (US$ 151 billion) in stocks in India during 2014. The total
investments in Indias equity market for the year 2014 were
US$43.5 billion (the highest in any fiscal year). There is a record
investment in assets, that is, US$ 26.3 billion out of the above
mentioned figure in 2014, and rest US$ 17.2 billion are through
equities. According to market experts, the debt flows have been
running strong due to existing high rate arbitrage, and people
had a positive view on the currency.

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Exhibits
Exhibit 1

Exhibit 2
Financia
l Year
20042005
20052006
20062007
20072008
20082009
20092010
20102011
20112012
20122013
20132014
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INR crores
Equit
y
44122.
7
48800.
5
25235.
7
53403.
8
47706.
2
11022
0.6
11012
1.1
43737.
6
14003
2.6
79708.
68

Debt
1758.6
7333.8
5604.7
12775.
3
1895.2
32437.
7
36317
49987.
9
28334.
4
28059.

Total
45881.
3
41466.
7
30840.
4
66179.
1
45811
14265
8.3
14643
8.1
93725.
5
16836
7
51648.
79

9
11133 16612 27745
2.6
7.1
9.7
201514181. 10179. 4002.0
2016
7
61
8
80523 31671 11219
Total
6.3
3.1
49
**up to November 19, 2015
20142015

Exhibit 3

Exhibit 4

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TREND OF FII AND REAL INTEREST RATE IN 13 YEARS

200,000
8.6
150,000

10
168,367
7.9
6.9
6.2

100,000
4.9
50,000

146,438
142,658

7.3

5.8

93,726

4.5 66,179 4.3

51,649
4

45,76545,88141,467
30,840

3.2

8,763 2,689
0

1.5
-45,811

-50,000

3.2
2

0
-0.6

-100,000

-2
IIP

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INTEREST RATE

Exhibit 5

Exhibit 6

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REFERENCES
SEBI,
http://www.sebi.gov.in/sebiweb/investment/statistic
s.jsp?s=fii, 18 November 2015
NSE India, http://www.nseindia.com/content/us/ismr2008ch8.pdf, 18
November 2015
Trading Economics,
http://www.tradingeconomics.com/india/interestrate,
18 November 2015
SSRN, http://papers.ssrn.com/sol3/papers.cfm?
abstract_id=2439077, 22 November 2015
RBI, http://dbie.rbi.org.in/DBIE/dbie.rbi?site=home,
22 November 2015
Money Control,
http://www.moneycontrol.com/india/stockmarket/fo
reigninstitutionalinvestors/13/50/activity/FII, 22
November 2015

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