Foreign Institutional Investments and Real Economic Growth in India: A Causality Test

Transcription

1 Inernaional Research Journal of Finance and Economics ISSN Issue 4 (200) EuroJournals Publishing, Inc hp:// Foreign Insiuional Invesmens and Real Economic Growh in India: A Causaliy Tes P. K. Mishra Siksha O Anusandhan Universiy, Bhubaneswar, Orissa, India, Pin pkmishra974@gmail.com K. B. Das Dep. of A&A Economics, Ukal Universiy, Bhubaneswar, Orissa, India, Pin drkumardas@gmail.com B. B. Pradhan Siksha O Anusandhan Universiy, Bhubaneswar, Orissa, India, Pin regisrar@soauniversiy.ac.in Absrac The role of invesmen in promoing economic growh has received considerable aenion in India since independence. Bu he role of foreign insiuional invesmen in he economic developmen of India is a recen opic of discussion among economiss and developmen planners. Since he implemenaion of he new economic policies in early 990s, India emerged as an imporan desinaion of global invesors invesmen. I is from Sepember 4, 992, FIIs have been invesing on financial insrumens in India and providing incenives for financial innovaions in he counry. Recenly, hey have become he movers and shakers of he marke. Given his growing imporance of FIIs for he Indian economy, i is essenial ha he dynamics of such cross-border porfolio invesmen in he conex of economic growh of he counry be examined. I is wih his aim an aemp has been made in his paper o es he causaliy beween foreign insiuional invesmens and he real economic growh in India over a period 993:Q o 2009:Q 2. The Granger Causaliy es in he VAR framework provides he evidence of bi-direcional causaliy running beween hese wo variables. Therefore, by he formulaion and implemenaion of prudenial norms concerning cross-border invesmens, he planners and policy makers in India can help he counry moving in a high growh rajecory. Keywords: Foreign Porfolio Invesmen, FIIs, Economic growh of India, Granger Causaliy Tes, Vecor Auo Regressive Model. JEL Classificaion Codes: C0, C22, E44, F2, F36, F4, G0, G28. Inroducion The less well known Foreign Insiuional Invesors (FIIs) have been a key par of India's growh sory his decade. The erm FIIs is mos commonly used o refer he companies ha are esablished or incorporaed ouside India and are invesing in he financial markes of India by regisering hemselves wih he Securiies & Exchange Board of India (SEBI). FIIs include overseas pension funds, muual

2 26 Inernaional Research Journal of Finance and Economics - Issue 4 (200) funds, invesmen russ, asse managemen companies, nominee companies, banks, insiuional porfolio managers, universiy funds, endowmens, foundaions, chariable russ, chariable socieies, a rusee or power of aorney holder incorporaed or esablished ouside India proposing o make proprieary invesmens on behalf of a broad-based fund (i.e., fund having more han 20 invesors wih no single invesor holding more han 0% of he shares or unis of he fund). Foreign Insiuional Invesmen is basically shor-erm in naure and mosly made in he financial markes. Foreign Insiuional Invesors (FIIs) are allowed o inves in he primary and secondary capial markes in India hrough he Porfolio Invesmen Scheme (PIS) adminisered by he Reserve Bank of India (RBI). Under his scheme, FIIs can acquire shares/debenures of Indian companies hrough he sock exchanges in India. The ceiling for overall invesmen by FIIs is 24 per cen of he paid up capial of he Indian company (20 per cen in he case of public secor banks, including he Sae Bank of India). The ceiling of 24 per cen for FII invesmen can be raised subjec o (i) approval by he company s board and he passing of a special shareholder resoluion o ha effec (ii) cerain secor caps imposed by RBI and he Governmen of India. The RBI moniors he ceilings on FII invesmens in Indian companies on a daily basis and publishes a lis of companies allowed o arac invesmens from FIIs wih heir respecive ceilings. The FIIs have been playing a significan role in he process of capial formaion and economic growh of he counry. There has been a dramaic increase in ne FII flows o India over he period , and especially over he bull rally ha climaxed in January 2008 when he Sensex reached a lifeime high of 2, poins. FIIs invesed US$7 billion in Indian socks in 2007 only. However, he onse of he recen global financial crisis saw FIIs pulling ou a record $3 billion (Rs 67,470) in 2008, he larges ouflows since India opened is doors o FIIs 5 years ago. The Economic Times has jus repored ha FII invesmen is up, wih he Indian Sock Marke aking in $3 billion so far in 2009 from foreign insiuions. This is in sark conras o he scenario in FIIs such as pension managers, invesmen houses and sovereign wealh funds have been boh a growh driver and a beneficiary of his growh, wih socks now worh more han double wha hey were a heir March lows. The key aspec of FII invesmen is ha as many as 20 new foreign insiuional invesors have regisered in India since he global financial crisis broke ou in Sepember These FIIs come from a diverse se of operaional areas, and includes names like American Airlines, Inernaional Finance Corporaion, Universiy of Souhern California, Bank of Korea, he Bill & Melinda Gaes Foundaion, and Warburg Pincus Inernaional. More imporanly, he monhs of Sepember-November, 2008 have seen regisraion of 358 new sub-accouns - he highes in any block of hree monhs in This shows ha we are a fairly large aracor of foreign insiuional invesmen. There are a number of reasons huge FII invesmen is being made in India. One of he main reasons for he FII flows has been an increased recogniion of he long-erm growh poenial of Indian economy. India offers favourable demographics and has quickly esablished is compeiive advanage in many spheres including sofware. Indian enrepreneurs have been quie successful in launching businesses in India. FIIs have recognised he fac and unlike oher counries where FDI has gained predominance, India has seen significan growh in FII invesmen. Though here could be emporary slowdown or reversals based on ineres rae cycles, flow of funds, global conagion ec, over he long erm, given he nascence of many Indian businesses and he growh poenial, one would see coninued inflows. Anoher reason may be he fac ha Indian s have he abiliy o produce goods and services a a lower cos. The scarciy of employmen opporuniies brings good compeiion in he labour force and auomaically improves he qualiy and produciviy which is highly favourable for foreign corporaions. Thus, here is hardly any big company in he enire world who does no have heir presence in Indian invesmen scene. This is he reason ha indusries like While an FII regisraion allows a fund manager o operae in he Indian markes, a separae sub-accoun is regisered for every disinc fund run by he FII o be invesed in India.

3 Inernaional Research Journal of Finance and Economics - Issue 4 (200) 27 BPO, IT and Manufacuring are seadily rising in India. Therefore, FII invesmen flow appears o influence and be influenced by he economic growh of India. I is wih his backdrop, his paper aemps o invesigae he causaliy beween he FII invesmen flow and economic growh in India. The res of he paper is organised as follows: Secion 2 discusses he daa and mehodology of he sudy; Secion 3 makes he analysis; and Secion 4 concludes. 2. Daa and Mehodology The objecive of his paper is o invesigae he direcion of relaionship beween FII invesmen and he economic growh in India. The sample period of he sudy spans from 993 o This sudy uses he quarerly ime series daa on wo variables, viz., he Ne FII invesmen flow o India and he Real GDP of India. The Ne FII invesmen flow o India is he value of FII inflows o equiies in India minus ha of ouflows from he counry in a monh. The daa on monhly ne FII flows have been colleced from he archives of SEBI and hen convered ino quarerly series. The second variable, Real GDP, is he quarerly esimaes of Gross Domesic Produc a facor cos and consan prices. Such GDP daa are colleced from he RBI daabase on Indian economy. The sudy employs he Granger causaliy es in he Vecor Auoregressive Regression framework o examine he causaliy beween FII invesmen flow o India and he real economic growh of he counry. This necessiaes he empirical analysis o be performed in hree seps: Firs, he saionariy es; second, he Coinegraion es; hird, he Granger causaliy es. A. Saionariy Tes The pre-requisie of coinegraion es is he saionariy of each individual ime series over he sample period. In his sudy, we relied on Augmened Dickey-fuller uni roo es o invesigae saionariy of each ime series as proposed by Dickey and Fuller (98). This ADF uni roo es requires he esimaion of he regression: Δ Y = α0 + αy + βiδ Y i + ε p i= Where Δ Y is he firs differences of hey, α 0 is he inercep, α are he coefficiens, is he ime or rend variable, p is he number of lagged erms chosen o ensure ha ε is he whie noise. The opimal lag lengh of p is seleced by using he Schwarz s informaion crieria (SIC) suggesed by Schwarz. The hypoheses of his es are: H : ρ = 0, i.e., here is a uni roo he ime series is non-saionary. 0 H : ρ < 0, i.e., here is no uni roo he ime series is saionary. If he esimaed - saisic (ADF es saisic) is found o be less han he criical value, he null hypohesis is acceped, oherwise rejeced. B. Coinegraion Tes In financial economics, wo variables are said coinegraed when hey have long-erm, or equilibrium relaionship beween hem (Engle and Granger, 987). Thus, in his sudy coinegraion analysis has been performed o invesigae long erm relaionship beween cross-border capial flows and real economic growh in India. The purpose of he coinegraion es is o deermine wheher a group of non-saionary series are coinegraed or no. We implemen VAR-based coinegraion es using he mehodology developed by Johansen (99, 995). The vecor auoregressive (VAR) model as considered in his sudy is: Y = AY + AY ApY p + BX + ε

4 28 Inernaional Research Journal of Finance and Economics - Issue 4 (200) Where Y is a k -vecor of non-saionary I() endogenous variables, X is a d -vecor of exogenous deerminisic variables, A... Ap and B are marices of coefficiens o be esimaed, and ε is a vecor of innovaions ha may be conemporaneously correlaed bu are uncorrelaed wih heir own lagged values and uncorrelaed wih all of he righ-hand side variables. Since mos economic ime series are non-saionary, he above saed VAR model is generally esimaed in is firs-difference form as: p Δ Y =Π Y + Γ Δ Y + BX + ε i i i= p p Π= Ai I, and Γ i = Aj i= j= i+ Where, Granger s represenaion heorem assers ha if he coefficien marix Π has reduced ' ' rank r < k, hen here exis k r marices α and β each wih rank r such ha Π= αβ and βy is I(0). r is he number of co-inegraing relaions (he co-inegraing rank) and each column of β is he co-inegraing vecor. α is he marix of error correcion parameers ha measure he speed of adjusmens in Δ Y. The Johansen approach o coinegraion es is based on wo es saisics, viz., he race es saisic, and he maximum eigenvalue es saisic. (a) Trace Tes Sais ic The race es saisic can be specified as: τ race k = T log( λi ), where λ i is he ih larges eigenvalue of marix Π, and T is he number of observaions. In he race es, he null hypohesis is ha he number of disinc coinegraing vecor(s) is less han or equal o he number of coinegraion relaions ( r ). (b) Maximum Eigenvalue Tes The maximum eigenvalue es examines he null hypohesis of exacly r coinegraing relaions agains he alernaive of r + coinegraing relaions wih he es saisic: τ = T log( λ ), max r + where λ r + is he ( r + ) h larges squared eigenvalue. In he race es, he null hypohesis of r = 0 is esed agains he alernaive of r + coinegraing vecors. C. Granger Causaliy Tes This sudy uses Granger Causaliy Tes proposed by C. W. J. Granger (969) for esing he causaliy beween ne FII invesmen flow o India and real economic growh. This es in he VAR framework formulaes he null and alernaive hypoheses as: H 0 : No causal relaion beween Ne FII invesmen flows and real economic growh H : Causaliy beween Ne FII invesmen flows and real economic growh These hypoheses are esed in he conex of he VAR of he form: n FII = α FII + β EG + ε i j j i= j= n n EG = λ EG + δ FII + ε i i j j 2 i= j= n Where FII is he raio of ne FII invesmen flows o India, and EG is he real economic growh as measured by real GDP. As is eviden from he ime series lieraure, he Granger Causaliy Tes is i= r+

5 Inernaional Research Journal of Finance and Economics - Issue 4 (200) 29 very sensiive o number of lags included in he model. In view of his, he Schwarz Informaion Crierion (SIC) for he selecion of appropriae lag lengh has been used. 3. Empirical Analysis This paper makes he empirical analysis by examining he causaliy beween foreign porfolio invesmen flow o India and he economic growh in he VAR framework. Since VAR assumes saionariy of he variables, we esed he order of inegraion of he variables using ADF uni roo es. The descripive saisics and he ADF uni roo es of he variables are presened in Table. The resuls show ha Ne FII invesmen flows and real GDP series are saionary a levels indicaing absence of rend and long run mean reversion. Thus, he variables are inegraed of same order, ie., I(0). The resuls of Johansen coinegraion es are summarized in Table 2. Table : Descripive Saisics and uni roo es of variables Ne FII Invesmen Flow (FII) Real GDP(EG) No. of Observaions Mean Median Maximum Minimum Sandard Deviaion Skewness Kurosis ADF Uni Roo Tes (Levels) (6) * 0.665(4) * *: denoes saisical significance a % level. Table 2: Coinegraion Tes of Variables Sample: 993 Q o 2009 Q 2 Sample (adjused): 993 Q 4 o 2009 Q 2 Included observaions: 63 afer adjusmens Trend assumpion: No deerminisic rend (resriced consan) Series: FII and GDP Lags inerval (in firs differences): o 2 Unresriced Coinegraion Rank Tes (Trace) Hypohesized Trace 0.05 No. of CE(s) Eigenvalue Saisic Criical Value Prob.** None * A mos * Trace es indicaes 2 coinegraing equaions a he 0.05 level *: denoes rejecion of he hypohesis a he 0.05 level **: MacKinnon-Haug-Michelis (999) p-values Unresriced Coinegraion Rank Tes (Maximum Eigenvalue) Hypohesized Max-Eigen 0.05 No. of CE(s) Eigenvalue Saisic Criical Value Prob.** None * A mos * Max-eigenvalue es indicaes 2 coinegraing equaions a he 0.05 level *: denoes rejecion of he hypohesis a he 0.05 level **: MacKinnon-Haug-Michelis (999) p-values The Trace es indicaes he exisence of wo coinegraing equaions a 5% level of significance. And, he maximum eigenvalue es makes he confirmaion of his resul. Thus, he wo variables of his sudy have long-run or equilibrium relaionship beween hem. Now, he causaliy es can be performed o deermine he direcion of causaion beween hese wo variables in he

6 220 Inernaional Research Journal of Finance and Economics - Issue 4 (200) environmen of VAR. This VAR model uses he lag lengh up o 7 as deermined by Akaike Informaion Crieria (AIC). The resuls of he Granger Causaliy Tes are shown in he Table 3. Table 3: Resuls of Granger Causaliy Tes Null Hypohesis Lag Lengh(AIC) Degrees of Freedom F-Saisic Probabiliy Decision Ne FII Invesmen Flows do no Granger-cause Real Economic Growh 7 (2, 20) 3.068* Rejec # Real Economic Growh does no Granger-cause Ne FII Invesmen Flows 7 (2, 20) * Rejec *: The criical value of F for (2, 20) degrees of freedom a %, 5% and 0% levels of significance are , , and respecively. #: Null hypohesis is rejeced a 0% level of significance. I is seen from he Table 3 ha boh he null hypoheses of his causaliy es are rejeced. I shows ha he FII invesmen flow o India can be a cause of he real economic growh of he counry. I is also inferred from he able-3 ha he growh of real GDP promoes he FIIs invesing in India. In oher words, he srong fundamenals of he counry as well as is robus growh poenial indeed aracs voluminous cross-border insiuional invesmen leading o a surge in he performance of macro-economic indicaors. During 200 and 2007, here has been a phenomenal increase in he porfolio invesmen by FIIs in he Indian marke wih he rend reversal in Again, 2009 is winessing coming back of FIIs in drove. Several facors are responsible for his increasing confidence of FIIs on he Indian marke which include srong macro-economic fundamenals of he economy, ransparen regulaory sysem, aboliion of long-erm capial gains ax, and encouraging corporae resuls. The pros of allowing FIIs o inves in he Indian markes far ouweigh he cons. The porfolio invesmen by he FIIs in India improves corporae capial srucures, helps bridging he invesmen gap, and promoes financial innovaion and developmen of hedging insrumens. Such invesmen flow no only enhances compeiion in financial markes, bu also improves he alignmen of asse prices o fundamenals. FIIs as professional bodies of asse managers and financial analyss enhance compeiion and efficiency of financial markes. FIIs consiue professional bodies of asse managers and financial analyss, who, by conribuing o beer undersanding of firms operaions, improve corporae governance. I has been a long sanding consensus ha he equiy marke developmen aids economic developmen of he counry. And, he case of India is no excepion. By increasing he availabiliy of riskier long-erm capial for projecs, and increasing firms incenives o provide more informaion abou heir operaions, FIIs can help in he process of economic developmen. Furhermore, FIIs incoming o India wih handful of invesmen resources will conribue o insiuionalizaion of he counry. Insiuionalizaion will increase dividend payous, and will enhance produciviy growh. 4. Conclusion This paper examined he causaliy beween FII porfolio inflows and real economic growh in Indian economy. The issue assumes much relevance in he conex of he almos non-exising lieraure and recen impacs of global financial crisis in India. In he vecor auoregressive framework his paper sudies he dynamics of ne inflow of cross-border insiuional invesmen and economic growh in India. The analysis provides he evidence of bi-direcional causaliy running from ne FII flows o real economic growh. This shows ha he real economic growh of India boh deermines and deermined by he volume of porfolio insiuional invesmens in he counry. The foreign insiuional invesmen inflows have he poenial of influencing he process of economic developmen of India hrough he posiive impacs on macro-economic fundamenals of he counry. Therefore, he oulook is ha he

7 Inernaional Research Journal of Finance and Economics - Issue 4 (200) 22 policy makers of India should provide he FIIs wih more opporuniies and reasons o inves in Indian markes by suggesing and implemening prudenial norms. References [] Banaji J., (998). Foreign Porfolio Invesmen in Indian Equiy Markes: Has he Economy Benefied? QEH Working Paper No. 54. [2] Bara, A., (2003). The Dynamics of Foreign Porfolio Inflows and Equiy Reurns in India. Working Paper No. 09. ICRIER, New Delhi, India. [3] Babu M. Suresh, and Prabheesh. K. P. (2008), Causal Relaionships beween Foreign Insiuional Invesmens and Sock Reurns in India, Inernaional Journal Trade and Global Markes, Vol., No. 3. pp [4] Chakrabari, R. (200), FII Flows o India: Naure and Causes, Money and Finance, Vol. 2, pp [5] Clark, J., and E. Berko, (997), Foreign Invesmen Flucuaions and Emerging Marke Sock Reurns: The Case of Mexico, Federal Reserve Bank of New York, Saff Repors 24. [6] Governmen of India, Minisry of Finance (2005): Repor of he Exper Group on Encouraging FII Flows and Checking he Vulnerabiliy of Capial Markes o Speculaive Flows, New Delhi, November. [7] Granger, C.W. J. (969), Invesigaing Causal Relaions by Economeric Mehods, and Cross Specral Mehods, Economerica, Vol. 37, pp [8] Griffin, J.M., Nardari, F. and Sulz, R.M. (2004), Are Daily Cross-Border Equiy Flows Pushed or Pulled?, The Review of Economics and Saisics, Vol. 86, pp [9] Gujarai D.N. (2007), Basic Economerics, McGraw-Hill Inernaional, New York, Fourh Ediion. [0] Johnson, J. and John Dinardo, (997), Economeric Mehods, McGraw-Hill Inernaional, MGHISE, 4h Ediion. [] Kim, W., and S.Wei, (2002), Foreign Porfolio Invesors Before and During A Crisis, Journal of Inernaional Economics, Vol. 5, pp [2] Kumar, Sundaram (2009), Invesigaing Causal Relaionship beween Sock Reurn wih Respec o Exchange Rae and FII: Evidence from India, MPRA Papers, May 0, BIITS, Pilani. [3] Mishra, P. K. (2009): Indian Capial Marke Revisiing Marke Efficiency, Indian Journal of Capial Markes, Vol. II, Issue. V, March, pp , Bombay Sock Exchange, India. [4] Mishra, P. K. and B. B. Pradhan, (2009): Capial Marke Efficiency and Financial Innovaion A Perspecive Analysis, The Research Nework, Vol.4, No., March, 2009, India. [5] Mishra, P. K., K. B. Das, and B. B. Pradhan, (2009): Capial Marke Volailiy An Economeric Analysis, The Empirical Economics Leer, Vol.8, No. 5, May, Bangladesh. [6] Mishra, P. K., K. B. Das, and B. B. Pradhan, (2009): Role of FIIs in Indian Capial marke, The Research Nework, Vol.4, No.2, July, India. [7] Mishra, P. K. and B. B. Pradhan, (2009): Financial Innovaion and is Impac on Reserve Bank Policies, Indian Journal of Economics, Prof. P. D. Hajela Memorial Volume, India. [8] Mishra, P. K., K. B. Das, and B. B. Pradhan, (2009): Empirical Evidence on Indian Sock Marke Efficiency in Conex of he Global Financial Crisis, Global Journal of Finance and Managemen, Vol., No.2, pp.49-57, India. [9] Mishra, P. K., K. B. Das, and B. B. Pradhan, (2009): Foreign Insiuional invesmen and Sock Reurns in India: A Causaliy Tes, Global Journal of Pure and Applied Mahemaics, Vol.5, No.2, Souh Korea.

8 222 Inernaional Research Journal of Finance and Economics - Issue 4 (200) [20] Mishra, P. K., K. B. Das, and B. B. Pradhan, (2009): Economic Growh: The Financial Innovaion Perspecive, BIFT s Journal of Inernaional managemen and Research, Vol., No.4, July-Sepember, pp.69-73, India. [2] Mishra, P. K. K., B. Das and B. B. Pradhan, (2009): Financial Innovaion and Economic Growh A Theoreical Approach, The Research Nework, Vol.4, No.3, Sepember, pp.59-64, India. [22] Mishra, P. K., K. B. Das, and B. B. Pradhan (2009): Role of Muual Funds in India: An Empirical Analysis, The Research Nework, Vol.4, Issue.4, December, India. [23] Mishra, P. K., K. B. Das and B. B. Pradhan (200): Global Financial Crisis and Sock Reurn Volailiy in India, Indian Journal of Finance, India. [Forhcoming] [24] Mukherjee, P., Bose, S. and Coondoo, D. (2002), Foreign Insiuional Invesmen in he Indian Equiy Marke: An Analysis of Daily Flows during January 999 May 2002, Money and Finance, Vol. 2, pp [25] Paerson, Kerry. (2002), An Inroducion o Applied Economerics-A Time Series Approach, Replika Press Pv. Ld., Delhi. [26] Samal, Kishore C., (997). Emerging Equiy Marke in India: Role of Foreign Insiuional Invesors, Economic and Poliical Weekly, Ocober 8, [27] Takeshi Inoue, (2008), The Causal Relaionships in Mean and Variance beween Sock Reurns and Foreign Insiuional Invesmen in India, IDE Discussion Paper, No.80.