impact of foreign institutional investors (fiis) and macro economic factors on indian stock markets

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This report provides summary regarding the sectors that are most influenced by FII investment and macro economic factors and tries to identify the risks an investor faces in these sectors.

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2012

IMPACT OF FOREIGN INSTITUTIONAL INVESTORS (FIIs) AND MACRO ECONOMIC FACTORS ON STOCK MARKETSThis report provides summary regarding the sectors that are most influenced by FII investment and macro economic factors and tries to identify the risks an investor faces in these sectors.

By:

Kumar Shreyas 10BSPHH011075

IBS Hyderabad 1/31/2012

TABLE OF CONTENTSContentsContents .................................................................................................................................................... 2 1. 2. 2.1. 2.2. 2.3. 3. 3.1. 3.2. 4. 4.1. ABSTRACT ..................................................................................................................................... 3 INTRODUCTION........................................................................................................................... 4 Objectives of the Project............................................................................................................. 9 Scope of the Project..................................................................................................................... 9 Limitations ................................................................................................................................. 10 DATA SOURCES & METHODOLOGY ................................................................................... 11 Data Sources .............................................................................................................................. 11 Methodology .............................................................................................................................. 12 ANALYSIS & FINDINGS............................................................................................................ 14 Regression Analysis of SENSEX and Sector Specific Indexes .............................................. 14

Findings.................................................................................................................................................. 22 5. Analysis of Automobile Sector: The auto companies analyzed are: ............................................ 23

Findings ................................................................................................................................................... 26 6.1 Conclusion ............................................................................................................................................. 27 During Bull Phase: .................................................................................................................................. 27 During Bear Phase: ................................................................................................................................. 27 During Stagnation Phase: ........................................................................................................................ 27

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1. ABSTRACTForeign Institutional Investors (FIIs) are investor or investment fund that is from or registered in a country outside of the one in which it is currently investing1.

FIIs can impact the factor productivity of the host country and can also affect the balance of payments. Foreign investments provide a channel through which host country may gain access to foreign capital. In this age of transnational capitalism, significant amounts of capital are flowing from developed world to emerging economies. Positive fundamentals combined with fast

growing markets have made India an attractive destination for FIIs. Portfolio investments brought in by FIIs have been the most dynamic source of capital after the opening up of Indian economy.

FIIs, given their short-term nature, can have bidirectional causation with the returns of other domestic financial markets such as money markets, stock markets, and foreign exchange markets. Hence, understanding the determinants of FII is very important for any emerging economy as FII exerts a huge impact on the domestic financial markets in the short run and a real impact in the long run. India, being a capital scarce country, has taken many measures to attract foreign investment since the beginning of reforms in 1991 when it opened its gates for FIIs.

A rational investor always tries to maximize his/her gains and minimize the risk while investing in stock markets. Given the volatility in Indian stock markets due to its high growth rate it is imperative to asses the risk involved in investing.

This report tries to identify the sectors which have been most impacted by the FII investment and macro economic factors. Then this report will try to formulate a framework using which an investor might asses the risks involved due to investment in those sectors. The report shall prove

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http://www.investopedia.com/terms/f/fii.asp 3

beneficial to the investors who are trying to maximize their returns in stock markets and minimize their risk.

2. INTRODUCTIONFIIs attracted by the fast growing economy of India and strong performance of Indian companies have been attracted towards India to an extent that India has gone on to become the preferred investment destination.

The primary reasons for India being a preferred destination for FIIs are: Global liquidity into the equity markets. Improved performance and competitiveness of Indian firms. Opening up of Indian economy. Cheap labor and other factors of production. Highly developed stock market and high degree of vigilance over it. Tax Incentives.

Terms related to FIIs2: Sub Account: Sub-account includes those foreign corporate, foreign individuals, and institutions, funds or portfolios established or incorporated outside India on whose behalf investments are proposed to be made in India by a FII.

Designated Bank: Designated Bank means any bank in India which has been authorized by the Reserve Bank of India to act as a banker to FII.

Domestic Custodian: Domestic Custodian means any entity registered with SEBI to carry on the activity of providing custodial services in respect of securities.

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http://investor.sebi.gov.in/faq/foreign%20institutional%20investor.html

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Broad Based Funds: Broad Based Fund means a fund established or incorporated outside India, which has at least twenty investors with no single individual investor holding more than 10% shares or units of the fund.

Entities that can register as FIIs in India are3: As FII: Pension Funds Mutual Funds Insurance Companies Investment Trusts Banks University Funds Endowments Foundations Charitable Trusts / Charitable Societies

Entities proposing to invest on behalf of broad based funds, are also eligible to be registered as FIIs6:

Asset Management Companies (AMC) Institutional Portfolio Managers Trustees Power of Attorney Holders

As Sub Accounts7: Partnership Firms Private Companies Public Companies Pension Funds Investment Trusts Individuals

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http://investor.sebi.gov.in/faq/foreign%20institutional%20investor.html

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Major regulations by Securities and Exchange Board of India (SEBI)4: The SEBI is the nodal agency for dealing with FIIs, and they have to obtain initial registration with SEBI. The SEBI's initial registration is valid for five years. The Reserve Bank of India's general permission to FIIs will also hold good for five years. Both will be renewable. FIIs can invest in all securities traded on the primary and secondary markets. FIIs can repatriate capital gains, dividends, incomes received by way of interest and any compensation received towards sale/renouncement of rights offering of shares. The total investments in equity and equity related instruments should be at least 70% of the aggregate of all the investments of the Foreign Institutional Investor in India. The cumulative debt investment limit for FII investments in Corporate Debt is USD 15 billion. The debt investment limit for FIIs in government debt in G-secs currently capped at $5 billion and cumulative investments under 2% of the outstanding stock of G-secs. The Foreign Institutional Investor is allowed to transact business only on the basis of taking and giving deliveries of securities bought and sold. A Foreign institutional Investor or a sub-account having an aggregate of securities worth INR 10 crore or more, as on the latest balance sheet date, can settle their only through dematerialised securities. Investment by individual FIIs cannot exceed 10% of paid up capital. Investment by foreign registered as sub accounts of FII cannot exceed 5% of paid up capital.

Role of FIIs: The Indian stock market has come of age and has substantially aligned itself with the international order.

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http://investor.sebi.gov.in/faq/foreign%20institutional%20investor.html

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Market has also witnessed a growing trend of 'institutionalization' that may be considered as a consequence of globalization. It is influence of the FIIs which changed the face of the Indian stock markets. Screen based trading and depository are realities today largely because of FIIs. FII which based the pressure on the rupee from the balance of payments position and lowered the cost of capital to Indian business. FIIs are the trendsetters in any market. They were the first ones to identify the potential of Indian technology stocks. When the rest of the investors invested in these scrips, they exited the scrips and booked profits.

Rolling settlement was introduced at the insistence of FIIs as they were uncomfortable with the badla system.

The FIIs are playing an important role in bringing in funds needed by the equity market. The increase in the volume of activity on stock exchanges with the a