Do Fiis Impact Volatility of Indian Stock Market ?: Jatinder Loomba
Do Fiis Impact Volatility of Indian Stock Market ?: Jatinder Loomba
Do Fiis Impact Volatility of Indian Stock Market ?: Jatinder Loomba
ABSTRACT
The Foreign Institutional Investors (FIIs) have emerged as noteworthy players in the Indian stock
market and their growing contribution adds as an important feature of the development of stock
markets in India. To facilitate foreign capital flows, developing countries have been advised to
strengthen their stock markets. As a result, the Indian Stock Markets have reached new heights
and became more volatile making the researches work in this dimension of establishing the link
between FIIs and Stock Market volatility. Hence, its an interesting topic to ascertain the role of
FIIs in Indian Capital Markets. This paper makes an attempt to develop an understanding of the
dynamics of the trading behaviour of FIIs and effect on the Indian equity market. The study is
conducted using daily data on BSE Sensex and FII activity over a period of 10 years spanning
from 01st Jan 2001 to 31st Dec 2011. It provides the evidence of significant positive correlation
between FII activity and effects on Indian Capital Market. The analysis also finds that the
movements in the Indian Capital Market are fairly explained by the FII net inflows.
KEYWORDS: Foreign Institutional Investors (FIIs), Indian Capital Market, BSE SENSEX.
______________________________________________________________________________
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Until the 1980s, there was a general reluctance towards foreign investment or private commercial
flows as Indias development strategy was focused on self-reliance and import substitution and
current account deficits were financed largely through debt flows and official development
assistance. A major development in our country, post 1991 has been liberalization of the
financial sector, especially that of capital markets. After the launch of the reforms, foreign
institutional investors (FIIs) from September 14, 1992, with suitable restrictions, were permitted
to invest in all securities traded on the primary and secondary markets, including shares,
debentures and warrants issued by companies which were listed or were to be listed on the Stock
Exchanges in India and in schemes floated by domestic mutual funds. A positive contribution of
the FIIs has been their role in improving the stock market infrastructure and the SEBI assured its
contribution towards its development.
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INTRODUCTION
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withdrawals of capital from the country at the time of recent financial crisis, they have emerged
as important players in the Indian capital market.
With over 20 million shareholders, India has the third largest investor base in the world
after the USA and Japan. Over 9,000 companies are listed on the stock exchanges, which are
serviced by approximately 7,500 stockbrokers. The Indian capital market is significant in terms
of the degree of development, volume of trading and its tremendous growth potential, as stated
by (Mehra Saniya 2007).
So basically, one can compute the correlation coefficient between the BSE Sensex and
FII flows. I found it to be a strong correlation between BSE SENSEX and FII activity in Indian
Capital Markets. This strong positive correlation always grabs the headlines. It is because of the
volatile nature of investors sentiments that FIIs are tracked so closely. It would not be prudent to
drive away foreign investors from investing in our country. I had mentioned the importance of
foreign capital in the context of a developing economy and that is precisely why the government
has been so keen on liberalizing the external financial sector since 1991. If one foreign investor
has had a good experience investing in our country, it builds up our reputation in the
international community and encourages more foreign investors to invest in our economy.
However, a crisis of any kind will create panic among foreign investors as well, and regaining
their trust and confidence in our economy will entail another mammoth task !
In India, FII has a positive impact on the stock market, corporate transparency and
governance norms. Equity Research, in particular, has significantly benefitted and compelled
investment banks to invest in a previously neglected resource. FII is a short term flow and
though it may appear as a regular flow, it has to be segregated from FDI and constantly
monitored.
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CONCEPTUAL FRAMEWORK
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We know that our country needs more than $150 billion over the next ten years. FII
inflows lower the cost of capital and benefit the economy as a whole. We have seen the benefit
of this to Indian Companies as they raise money cheaply to finance their capital expenditure
programmes. Besides FII inflows, raising the level of transparency/ disclosure and improved
corporate governance standards in the system. In the end what really matters is that capital is
made available to the businesses and that purpose is served equally by FII capital.
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However, there is another way in which a country can attract foreign money. This is by
way of Foreign Direct Investment (FDI). However there is a slight difference between them. FDI
is defined as long term investment/ acquisition and is associated with investment in capital
assets that a parent company makes in a foreign country which eventually leads to creating
employment in India. It manifests in various forms i.e. leading to change in management,
transfer of technology, increase in production etc. Examples of FDI would include POSCO
setting up a steel plant in Orissa (in-bound FDI), Tata buying Arcelor (out-bound FDI) and so on.
It is perceived to be beneficial because it increases production, brings in more and better
products and services besides increasing the employment opportunities and revenue for the
Government by way of taxes. Considering the investment is long term in nature, they cannot be
immediately converted into cash and are often only liquidated in a worst-case scenario.
Whereas;
FII is a short term investment by foreign institutions, in the financial markets of other
countries. These institutions are generally mutual funds, investment companies, pension funds
and insurance houses. The SEBI is the nodal agency for dealing with FIIs and they have to obtain
initial registration with SEBI. For granting registration to an FII, the SEBI takes into account the
track record of the FII, its professional competence, financial soundness, experience and such
other criteria as may be considered relevant by SEBI. Besides, FIIs seeking initial registration
with SEBI, they will be required to hold a registration from an appropriate foreign regulatory
authority in the country of domicile/ incorporation of the FII. The rules and regulations to enter
the Indian market are not much. The fluctuations in the stock market are generally due to the FII
investments as the investor can leave the market at any point of time.
FII widens and deepens the stock exchanges and provides a better price discovery process
for the scripts. It is a fair-weather friend and can desert the nation with what is happening in
India right now, thereby pulling down not only our share prices but also wrecking havoc with the
Indian rupee because when FIIs sell in a big way and leave India they take back the dollars they
had brought in.
In countries like India, statutory agencies like SEBI have prescribed norms to register
FIIs and also to regulate such investments flowing in through FIIs. Yet, we intuitively know that
the FIIs are important for the market. They typically start a market rally. Subsequently flows
come from all classes of investors. At this stage, the market behaves like a self-organised system.
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Bombay Stock Exchange (BSE) which is one of the oldest in the world and accounts for
the largest number of listed companies and has also started a screen-based trading system with
the introduction of the Bombay On-Line Trading system. There are 23 recognized stock
exchanges in India, including the Over the Counter Exchange of India (OTCEI) for small and
new companies and the National Stock Exchange (NSE) which was set up as a model exchange
to provide nation-wide services to investors. NSE, which in the recent past has accounted for the
largest trading volumes, has a fully automated screen based system that operates in the wholesale
debt market segment as well as the capital market segment.
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No single class of investors drives the market asset prices go up, driven by the collective
momentum of all investors. Finally, the market enters the state of self-organised critically. This
is when any negative information could have non-linear effect on the market. The FIIs play a
major role during this phase too. So, why is a rise or decline in the market always attributed to
the FIIs ? How relevant are FIIs to derive the market rally ? A simple model using FII
investments, change in their investments and market returns shows that FIIs do not drive asset
returns. The relationship is also not significant if asset returns are used with a time lag. This
brings us to the point about the FIIs and the market. The FIIs do matter because their entry starts
off a market rally. Further, their exit or rumours of their exit at best temporarily halts the rally.
At worst, their exit could halt the rally completely. But the FII factor is not very important when
the market functions as a self-organised system. This phase has a longer duration than the entry
and exit phase of the rally. That is why statistical models suggest that FII flows do not drive
market returns even though they do.
Further, FIIs can repatriate capital gains, dividends, incomes received by way of interest
and any compensation received towards sale/renouncement of rights offering of shares subject to
payment of withholding tax at source. The net proceeds can be remitted at market rates of
exchange. The FIIs are playing an important role in bringing in funds needed by the equity
market. Additionally, they are contributing to the foreign exchange inflow as the funds from
multilateral finance institutions and FDI are insufficient. However, the fact remains that FII
investments are volatile and market driven, but this risk has to be taken if the country has to
ensure steady inflow of foreign funds.
The stock market shows more reaction to foreign investment as the economy liberalizes.
A concern with the entry of FIIs is that they are positive feedback traderstraders who buy
when the market increases and sell when the market falls. This acts as destabilizing factor
because the sales by FIIs lead the stock market to fall further and their buys increase the stock
market as concluded by (Dornbusch and Park, 1995), (Radelet and Sachs, 1998). Not only this,
these trades push the stock-prices away from the fundamentals as revealed by studies on
contemporaneous relation between FIIs investments and equity returns based on monthly data
(Bohn and Tesar, 1996, Berko and Clark, 1997).
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REVIEW OF LITERATURE
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(Choe et. al., 1998) examined the influence of FIIs on equity returns in Korea before and
during the 1997 Asian crisis and they found no evidence of stock prices falling because of a
withdrawal of foreign equity investment. Also, it is not necessary that inviting FIIs to the stock
market would increase its volatility as argued by (Rene and Stultz, 1997).
(Douma, Kabir and Rejie 2006) investigated the impact of foreign institutional
investment on the performance of emerging market firms and found that there is positive effect
of foreign ownership on firm performance. They also found impact of foreign investment on the
business group affiliation of firms. (Aggarwal, Klapper and Wysocki, 2005) observed that
foreign investors preferred the companies with better corporate governance.
(Gordon and Gupta, 2003) found causation running from FII inflows to return in BSE.
They observed that FIIs act as market makers and book profits by investing when prices are low
and selling when they are high. Hence, there are contradictory findings by various researchers
regarding the causal relationship between FII net inflows and stock market capitalization and
returns of BSE/ NSE. Therefore, there is a need to investigate whether FIIs are the cause or
effect of stock market fluctuations in India.
(Choe, Kho and Stulz, 1998) have examined the impact of foreign investors on stock
returns in Korea before and after the 1997 Asian crisis using daily trade data. They find evidence
of positive feedback trading before the crisis. During the crisis period their study reveals a
weakening of the herding effect and disappearance of positive feedback trading by foreign
investors. In addition they find no evidence of a destabilizing effect of the trades by foreign
investors on Koreas stock market. Using the measure for herding as developed by (Lakonishok,
Shleifer and Vishny, 1992), (Kim and Wei, 2002) also show strong tendencies for herding by
foreign investors and offshore investment funds in Korea in a similar time period.
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(Jeong-Bon and Li 2004) found that foreign investors tend to avoid stocks with high cross
corporate holdings. They suggested that FII are likely to be efficient processors of public
information and are attracted to Japanese firms with low information asymmetry. (Morin, 2000)
explored the influence of French model of shareholding and management on FII. They
commented that France has undergone rapid change from a financial network economy to a
financial market economy. The new pattern has broken the traditional system of cross holding
and facilitated the arrival of FII who bring with them new techniques and demands efficient
corporate management. There is a growing literature on the determinants of global investment
flows and allocations.
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(Dahlquist et al., 2003) analysed foreign ownership and firm characteristics for the
Swedish market. They found that foreigners have greater presence in large firms, firms paying
low dividends and in firms with large cash holdings. They explained that firm size is driven by
liquidity. They measured international presence by foreign listings and export sales. They
reiterated that foreigners tend to underweight the firms with a dominant owner. (Covirg et al.,
2007) concluded that foreign fund managers have less information about the domestic stocks
than the domestic fund managers. They found that ownership by foreign funds is related to size
of foreign sales, index memberships and stocks with foreign listing.
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Most of the existing literature on FIIs in India found that the equity return has a
significant and positive impact on the FIIs and stock returns are strongly correlated in India
(Agarwal, 1997, Chakrabarti, 2001 and Nair and Trivedi, 2003). But, given the huge volume of
investments, foreign investors could play a role of market makers and book their profits, i.e. they
can buy financial assets when the prices are declining, thereby jacking-up the asset prices and
sell when the asset prices are increasing (Gordon and Gupta, 2003). The possibility of bidirectional relationship between FII and the equity returns was explored by (Bhanumurthy and
Rai, 2003). They studied the determinants of foreign institutional investment in India during the
period 1994-2002. They found, using monthly data that the equity returns is the main driving
force for FII investment and is significant at all levels. They further studied the impact of news
on FII flows and found that the FIIs react more (sell heavily) to bad news than to good news.
(Bonser-Neal et al., 2002) analyze the foreign trading behaviour on the Jakarta stock
exchange (Indonesia) between 1995 and 2000. They concluded positive correlation, but, found
no evidence to indicate that such trading behaviour by foreign investors destabilized the market
prices during the Asian crisis. (Griffin et al., 2002) using theoretical model and empirically
analysing showed that global stock return performance is an important factor in understanding
equity flows. (Anthony and Richards, 2002) detected a strong evidence of positive corelationship with respect to domestic, US and regional equity returns, using data for daily net
purchases by foreigners in six Asian emerging equity markets over 1999-2001. As against the
existing empirical literature that emphasises largely on stock/ firm level analysis, my study has
broader coverage. It attempts to analyze aggregate trading by FIIs in India rather than stock level
trades of individual investors. Further, keeping in view the greater possibility of homogeneity of
trading behaviour in one group, our analysis includes all the FIIs rather than one subset of FIIs as
has been the case in earlier studies relating to feedback trading and herding.
2.
3.
HYPOTHESES
Ho1 : No significant relation exists between BSE SENSEX Absolute Change and FII Activity in
Indian Capital Market.
Ho2: No significant relation exists between BSE SENSEX Percentage Change and FII Activity in
Indian Capital Market.
RESEARCH METHODOLOGY
The study is descriptive in nature. The total population includes BSE SENSEX and the
FIIs and the secondary data was collected through the official website of Bombay Stock
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1.
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Exchange of India Limited. For calculation, daily BSE SENSEX data was taken and absolute
change was calculated. On the same data, percentage change was calculated. The measure of
percentage change provides a better picture of the scenario over the absolute change as it is
expressed as a comparison to the size of one or both of them. Such measures are often used as
more authentic indicators for repeated measurements where the outcomes are expected to be the
same. It is a way to express a change in a variable compared to its starting value. Top 25 losses
were found out from the total data of 10 years which was then compared with FII Net
investments (Net Purchase/Sales) to find out the effect of FII activity on BSE SENSEX which
acted as the sample size. The period for which the study was conducted is 10 years (01-Jan-2001
to 31-Dec 11). Individual BSE SENSEX and FII Investment acted as the sample elements.
Purposive sampling technique was used to collect the data.
TOOL USED FOR DATA ANALYSIS
Pearson correlation was used as the data sets were real and it gives an informative and
accurate statement of the strength of the linear association between the two variables. Here, our
variables are BSE SENSEX and FII Investments.
RESULTS AND DISCUSSION
Ho1 : No significant relation exists between BSE SENSEX Absolute Change and FII Activity in
Indian Capital Market.
Date
Open
High
Low
Close
Absolute
Change
21-Jan-08
18919.57
18919.57
16951.50
17605.35
-1314.22
-3296.73
06-Jul-09
14962.12
15097.87
13959.44
14043.40
-918.72
-1483.03
07-Jan-09
10424.96
10469.72
9510.15
9586.88
-838.08
-1111.25
24-Oct-08
9535.41
9570.71
8566.82
8701.07
-834.34
-1431.56
18-Oct-07
18827.46
19198.66
17771.16
17998.39
-829.07
-1130.59
11-Feb-08
17427.34
17427.34
16457.74
16630.91
-796.43
-1268.67
17-Oct-08
10763.34
10786.93
9911.32
9975.35
-787.99
-915.54
18-May-06
12163.98
12163.98
11330.45
11391.43
-772.55
-865.39
86
S.No.
FII
Activity
(Rs.
In
Cr.)
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17-Dec-07
20032.67
20032.67
19177.19
19261.35
-771.32
-2151.21
10
24-Jan-08
17920.98
18185.10
17070.05
17221.74
-699.24
-2254.93
11
07-Feb-08
18198.68
18198.68
17492.28
17526.93
-671.75
-860.35
12
20-Jun-08
15194.73
15202.01
14519.27
14571.29
-623.44
-999.31
13
19-May-06
11549.67
11697.11
10799.01
10938.61
-611.06
-1459.21
14
21-Nov-07
19197.57
19218.88
18515.30
18602.62
-594.95
-2007.70
15
22-May-06
11071.63
11142.90
9826.91
10481.77
-589.86
-872.49
16
15-Jan-08
20836.47
20872.93
20203.63
20251.09
-585.38
-365.09
17
31-Mar-08
16226.66
16226.66
15563.15
15644.44
-582.22
-865.79
18
18-Jan-08
19579.61
19715.78
18930.42
19013.70
-565.91
-2146.92
19
11-Nov-08
10405.39
10405.39
9799.45
9839.69
-565.70
-370.95
20
11-Jul-08
14032.06
14066.36
13351.34
13469.85
-562.21
-467.67
21
04-Apr-08
15896.09
15896.09
15303.04
15343.12
-552.97
-467.67
22
03-Mar-08
17227.56
17227.56
16634.63
16677.88
-549.68
-711.31
23
02-Jun-08
16591.46
16632.72
15991.21
16063.18
-528.28
-349.84
24
21-Aug-07
14512.19
14534.51
13941.93
13989.11
-523.08
-138.24
25
17-Mar-08
15326.93
15326.93
14738.27
14809.49
-517.44
-658.22
87
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Vol.1 Issue 7, July 2012, ISSN 2277 3622
Pearson
obtained
Correlation Resultant
Significance
Relationship
Confidence Level of 95 %
0.50
0.672
Significantly Strong
Analysing Table 1 using correlation, the results of which are indicated in table 2, it can be
concluded that there is statistically significant relation between BSE SENSEX absolute change
and FII activity in Indian Capital Market. Hence, the null hypothesis is rejected.
Ho2 : No significant relation exists between BSE SENSEX Percentage Change and FII Activity
in Indian Capital Market.
TABLE 3: TOP 25 PERCENTAGE LOSSES IN SENSEX AND FII ACTIVITY
High
Low
Close
24Oct08
9535.41
8566.82
8701.07
-8.75
-834.34
1431.56
07Jan09
9586.88
-8.04
-838.08
1111.25
17Oct08
9975.35
-7.32
-787.99
-915.54
21Jan08
-1314.22
3296.73
06Jul-09
-918.72
1483.03
9570.71
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Open
88
S.No. Date
FII
Percentage Absolute Activity
Change
Change (Rs. In
Cr.)
IRJC
10
11
12
13
14
15
16
17
11Nov08
9839.69
-5.44
-565.70
-370.95
22May06
10481.77 -5.33
-589.86
-872.49
19May06
-611.06
1459.21
25Nov08
9160.50
-5.08
-464.97
-161.88
11Feb08
-796.43
1268.67
9182.80
8649.40
8695.53
18Oct07
-829.07
1130.59
14Nov08
9799.25
-4.22
-413.83
-811.52
20Jun08
-623.44
-999.31
11Jul-08
-562.21
-467.67
05Mar09
8535.03
-337.11
-590.92
-482.79
1169.33
-514.21
-590.92
06Oct08
29Sep-
9836.11
8535.03
9267.49
8166.97
9385.42
8197.92
-3.95
89
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19
20
21
22
23
24
25
24Jan08
-699.24
2254.93
15Oct08
-436.15
1030.79
17Dec07
-771.32
2151.21
07Feb08
-671.75
-860.35
15May06
-450.44
-812.43
21Aug07
-523.08
-138.24
31Mar08
-582.22
-865.79
17Dec08
-357.81
-188.65
9715.29
-3.55
90
18
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08
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International Journal of Marketing, Financial Services & Management Research
Vol.1 Issue 7, July 2012, ISSN 2277 3622
Pearson
obtained
Correlation Resultant
Significance
Relationship
Confidence Level of 95 %
0.50
0.78
Significantly Strong
Analysing Table 3 using correlation, the results of which are indicated in Table 4, it can be
concluded that there is statistically significant relation between BSE SENSEX percentage change
and FII activity in Indian Capital Market. Hence, the null hypothesis is rejected.
CONCLUSION
The results of my research conveys that, FIIs are strong forces driving the Indian Stock
Market which is evident from top twenty five crashes at BSE SENSEX as FIIs were the net
sellers in all the leading market crashes. This study further gives the scope for identifying the
role of FIIs in India in overall market volatility.
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In the course of capital market liberalization, foreign capital has become increasingly
significant source of finance. Hence there has been growing presence of FIIs in Indian stock
market evidenced by increase in their nut cumulative investments. This shows that Indian stock
markets have become lively in terms of their composition of various constituents of the market.
On the other side, the increasing presence of this class of investors leads to reform of securities
market in terms of trading and transaction systems, making local markets at par with the
international markets. In developing countries like India, foreign capital helps in escalating the
productivity of labour and to build up foreign exchange reserves to meet the current account
deficit. The increase in FIIs investments brings inflow of capital and the country can have access
to foreign capital; however, there are limits in India for FII investment in a single firm. On the
flip side, foreign capital is free and unpredictable and is always on the lookout of profit, the
reason being, the portfolio managers of these FIIs are always on their toes for booking profits for
their dynamic portfolios across countries. There are speculations of broader range on the
expectations of foreign institutional investors. It is essential to understand when they withdraw
their funds and when they pump in more money. Hence, increased volatility associated with FII
investments result in severe price fluctuations which cannot be ignored.
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The Indian stock markets have come of age where there are significant developments in the last
15 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.
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