TERM PAPER FDI AND FII IN INDIA

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1 A TERM PAPER ON FDI AND FII IN INDIA SUBMITTED TO: DR. SAMPADA KAPSE SUBMITTED BY: LEENA KANJANI (08080) SULABH MAHETA (08084) ANITA PARYANI (08096) AMIN PATTANI (08100) MEHUL RAKHOLIYA (08101) KRISHNA VYAS (08118) INTRODUCTION Tolani Institute of Management Studies 1

2 The FDI and FII is the process by which the resident of one country (the source country) acquire the ownership of assets for the purpose of controlling the production, distribution and other productive activities of a firm in another country(the host country). According to the international monetary fund (IMF), FDI and FII is defined as an investment that is made to acquire a lasting interest in an enterprise operating in an economy other than that of investor. The effect of foreign investment, however, varies from country to country. It can affect the factor productivity of the recipient country and can also affect the balance of payments. Foreign investment provides a channel through which countries can gain access to foreign capital. It can come in two forms: FDI and foreign institutional investment (FII). Foreign direct investment involves in direct production activities and is also of a medium- to long-term nature. But foreign institutional investment is a short-term investment, mostly in the financial markets. FII, given its 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 larger 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 India is the second largest country in the world, with a population of over 1 billion people. As a developing country, India s economy is characterized by wage rates that are significantly lower than those in most developed countries. These two traits combine to make India a natural destination for FDI and foreign institutional investment (FII). Until recently, however, India has attracted only a small share of global FDI and FII primarily due to government restrictions on foreign involvement in the economy. But beginning in 1991 and accelerating rapidly since 2000, India has liberalized its investment regulations and actively encouraged new foreign investment, a sharp reversal from decades of discouraging economic integration with the global economy. Tolani Institute of Management Studies 2

3 The world is increasingly becoming interdependent. Goods and services followed by the financial transaction are moving across the borders. In fact, the world has become a borderless world. With the globalization of the various markets, international financial flows have so far been in excess for the goods and services among the trading countries of the world. Of the different types of financial inflows, the FDI and foreign institutional investment (FII)) has played an important role in the process of development of many economies. Further many developing countries consider FDI and FII as an important element in their development strategy among the various forms of foreign assistance. The FDI and FII flows are usually preferred over the other form of external finance, because they are not debt creating, nonvolatile in nature and their returns depend upon the projects financed by the investor. The FDI and FII would also facilitate international trade and transfer of knowledge, skills and technology. The government of India (GOI) has also recognized the key role of the FDI and FII in its process of economic development, not only as an addition to its own domestic capital but also as an important source of technology and other global trade practices. In order to attract the required amount of FDI and FII it has bought about a number of changes in its economic policies and has put in its practice a liberal and more transparent FDI and FII policy with a view to attract more FDI and FII inflows into its economy. These changes have heralded the liberalization era of the FDI and FII policy regime into India and have brought about a structural breakthrough in the volume of FDI and FII inflows in the economy. In this context, this report is going to analyze the trends and patterns of FDI and FII flows into India during the post liberalization period that is 2006 to 2009 year. OBJECTIVES Examines the trends and patterns in the FDI across different sectors and from different countries in India during 2000 to Tolani Institute of Management Studies 3

4 Influence of FII on movement of Indian stock exchange during period that is September 2006 to September To understand the FII & FDI policy in India. METHODOLOGY In order to accomplish this project successfully we will take following steps. Data collection: Tolani Institute of Management Studies 4

5 Secondary Data: Internet, newspapers, journals and books, other reports and projects, literatures FDI: The study is limited to a sample of top 10 investing countries e.g. Mauritius, Singapore, USA etc. and top 10 sectors e.g. service sector, computer hardware and software, telecommunications etc. which had attracted larger inflow of FDI from different countries. FII: Correlation: We have used the Correlation tool to determine whether two ranges of data move together that is, how the Sensex, Bankex, IT, Power and Capital Goods are related to the FII which may be positive relation, negative relation or no relation. We will use this model for understanding the relationship between FII and stock indices returns. FII is taken as independent variable. Stock indices are taken as dependent variable Hypothesis Test: If the hypothesis holds good then we can infer that FIIs have significant impact on the Indian capital market. This will help the investors to decide on their investments in stocks and shares. If the hypothesis is rejected, or in other words if the null hypothesis is accepted, then FIIs will have no significant impact on the Indian bourses. FOREIGN DIRECT INVESTMENT In this section we are going to discuss or describe the main business of the report i.e. analysis of secondary data. It includes data in an organized form, discussion on its significance and analyzing the results. For this we had divided this section in further Tolani Institute of Management Studies 5

6 two subsections i.e. the first subsection fulfill the requirement of first objective which is pertaining to FDI. Objective 1: Examine the trends and patterns in the FDI across different sectors and from different countries in India during 2000 to I. About foreign direct investment. Is the process whereby residents of one country (the source country) acquire ownership of assets for the purpose of controlling the production, distribution, and other activities of a firm in another country (the host country). The international monetary fund s balance of payment manual defines FDI as an investment that is made to acquire a lasting interest in an enterprise operating in an economy other than that of the investor. The investors purpose being to have an effective voice in the management of the enterprise. The united nations 1999 world investment report defines FDI as an investment involving a long term relationship and reflecting a lasting interest and control of a resident entity in one economy (foreign direct investor or parent enterprise) in an enterprise resident in an economy other than that of the foreign direct investor ( FDI enterprise, affiliate enterprise or foreign affiliate). II. Foreign direct investment: Indian scenario FDI is permitted as under the following forms of investments Through financial collaborations. Through joint ventures and technical collaborations. Through capital markets via Euro issues. Through private placements or preferential allotments. Forbidden Territories: Arms and ammunition Atomic Energy Coal and lignite Rail Transport Tolani Institute of Management Studies 6

7 Mining of metals like iron, manganese, chrome, gypsum, sulfur, gold, diamonds, copper, zinc. Foreign Investment through GDRs (Euro Issues) Indian companies are allowed to raise equity capital in the international market through the issue of Global Depository Receipt (GDRs). GDR investments are treated as FDI and are designated in dollars and are not subject to any ceilings on investment. An applicant company seeking Government's approval in this regard should have consistent track record for good performance (financial or otherwise) for a minimum period of 3 years. This condition would be relaxed for infrastructure projects such as power generation, telecommunication, petroleum exploration and refining, ports, airports and roads. 1. Clearance from FIPB There is no restriction on the number of Euro-issue to be floated by a company or a group of companies in the financial year. A company engaged in the manufacture of items covered under Annex-III of the New Industrial Policy whose direct foreign investment after a proposed Euro issue is likely to exceed 51% or which is implementing a project not contained in Annex-III, would need to obtain prior FIPB clearance before seeking final approval from Ministry of Finance. 2. Use of GDRs The proceeds of the GDRs can be used for financing capital goods imports, capital expenditure including domestic purchase/installation of plant, equipment and building and investment in software development, prepayment or scheduled repayment of earlier external borrowings, and equity investment in JV/WOSs in India. I. Foreign direct investments in India are approved through two routes 1. Automatic approval by RBI The Reserve Bank of India accords automatic approval within a period of two weeks (subject to compliance of norms) to all proposals and permits foreign equity up to 24%; 50%; 51%; 74% and 100% is allowed depending on the category of industries and the sectoral caps applicable. The lists are comprehensive and cover most industries of interest to foreign companies. Investments in high priority industries or for trading companies primarily engaged in exporting are given almost automatic Tolani Institute of Management Studies 7

8 approval by the RBI. 2. The FIPB Route Processing of non-automatic approval cases FIPB stands for Foreign Investment Promotion Board which approves all other cases where the parameters of automatic approval are not met. Normal processing time is 4 to 6 weeks. Its approach is liberal for all sectors and all types of proposals, and rejections are few. It is not necessary for foreign investors to have a local partner, even when the foreign investor wishes to hold less than the entire equity of the company. The portion of the equity not proposed to be held by the foreign investor can be offered to the public. iii. Analysis of sector specific policy for FDI Sr. No. Sector/Activity FDI cap/equity Entry/Route 1. Hotel & Tourism 100% Automatic 2. NBFC 49% Automatic 3. Insurance 26% Automatic 4. Telecommunication: Automatic cellular, value added services 49% Tolani Institute of Management Studies 8

9 74% 100% 51% 100% Above 49% need Govt. licence Automatic Automatic 6. Power(other than atomic reactor power plants) 100% Automatic 7. Drugs & Pharmaceuticals 100% Automatic 8. Roads, Highways, Ports and Harbors 100% Automatic 9. Pollution Control and 100% Automatic Management 10 Call Centers 100% Automatic 11. BPO 100% Automatic 12. For NRI's and OCB's: i. 34 High Priority Industry Groups 100% Automatic ISPs with gateways, radiopaging Electronic Mail & Voice Mail 5. Trading companies: primarily export activities bulk imports, cash and carry wholesale trading ii. Export Trading Companies iii. Hotels and Tourismrelated Projects iv. Hospitals, Diagnostic Tolani Institute of Management Studies 9

10 Centers v. Shipping vi. Deep Sea Fishing vii. Oil Exploration viii.power ix. Housing and Real Estate Development x. Highways, Bridges and Ports xi. Sick Industrial Units xii. Industries Requiring Compulsory Licensing 13. Airports: xiii.industries Reserved for Small Scale Sector Greenfield projects Existing projects 100% 100% Automatic Beyond 74% FIPB 14 Assets reconstruction company 49% FIPB 15. Cigars and cigarettes 100% FIPB 16. Courier services 100% FIPB 17. Investing companies in 49% FIPB Tolani Institute of Management Studies 10

11 infrastructure (other than telecom sector) iii. Analysis of FDI inflow in India From April 2000 to August 2009 (Amount US$ in Millions) S.No Financial Year Total FDI % Growth Over Inflows Previous Year , ,130 (+) ,035 (-) ,322 (-) ,051 (+) ,961 (+) ,826 (+) ,362 (+) ,168 (+) ( Up to August 2009) 16, iv. Analysis of share of top ten investing countries FDI equity in flows From April 2000 to August 2009 Tolani Institute of Management Studies 11

12 (Amount in Millions) Sr. No Country Amount of FDI Inflows % As To Total FDI Inflow 1. Mauritius 19,18, Singapore 3,80, U.S.A. 3,32, U.K. 2,40, Netherlands 1,78, Japan 1,50, Cyprus 1,32, Germany 1,12, France 61, U.A.E. 50, Mauritius Mauritius invested Rs.19,18,633 million in India Up to the August 2009, equal to percent of total FDI inflows. Many companies based outside of India utilize Mauritian holding companies to take advantage of the India- Mauritius Double Taxation Avoidance Agreement (DTAA). The DTAA allows foreign firms to bypass Indian capital gains taxes, and may allow some India-based firms to avoid paying certain taxes through a process known as round tripping. The extent of round tripping by Indian companies through Mauritius is unknown. However, the Indian government is concerned enough about this problem to have asked the government of Mauritius to set up a joint monitoring mechanism to study these investment flows. The potential loss of tax revenue is of particular concern to the Indian government. These are the sectors which attracting more FDI from Mauritius Electrical equipment Gypsum and cement products Telecommunications Services sector that includes both non- financial and financial Fuels. Singapore Tolani Institute of Management Studies 12

13 Singapore continues to be the single largest investor in India amongst the Singapore with FDI inflows into Rs. 3,80,142 crores up to August Sector-wise distribution of FDI inflows received from Singapore the highest inflows have been in the services sector (financial and non financial), which accounts for about 30% of FDI inflows from Singapore. Petroleum and natural gas occupies the second place followed by computer software and hardware, mining and construction. U.S.A. The United States is the third largest source of FDI in India (7.64 % of the total), valued at crore in cumulative inflows up to August According to the Indian government, the top sectors attracting FDI from the United States to India are fuel, telecommunications, electrical equipment, food processing, and services. According to the available M&A data, the two top sectors attracting FDI inflows from the United States are computer systems design and programming and manufacturing U.K. The United Kingdom is the fourth largest source of FDI in India (5.53 % of the total), valued at 2,40,974 crores in cumulative inflows up to August Over 17 UK companies under the aegis of the Nuclear Industry Association of UK have tied up with Ficci to identify joint venture and FDI possibilities in the civil nuclear energy sector. UK companies and policy makers the focus sectors for joint ventures, partnerships, and trade are non-conventional energy, IT, precision engineering, medical equipment, infrastructure equipment, and creative industries. Netherlands FDI from Netherlands to India has increased at a very fast pace over the last few years. Netherlands ranks fifth among all the countries that make investments in India. The total flow of FDI from Netherlands to India came to Rs. 1, 78,047 crores between 1991 and The total percentage of FDI from Netherlands to India stood at 4.08% out of the total foreign direct investment in the country up to August Following Various industries attracting FDI from Netherlands to India are: Tolani Institute of Management Studies 13

14 Food processing industries Telecommunications that includes services of cellular mobile, basic telephone, and radio paging Horticulture Electrical equipment that includes computer software and electronics Service sector that includes non- financial and financial services iii. Analysis of sectors attracting highest FDI equity inflows From April 2000 to August 2009 (Amount in Millions) Sr. No Country Amount of FDI Inflows % As To Total FDI Inflow 1. Service Sector 9,65, Tolani Institute of Management Studies 14

15 (Financial & Non Financial) 2. Computer Software & Hardware 4,13, Telecommunication 3,68, Housing & Real Estate 3,25, Construction Activities 2,65, Automobile Industry 1,90, Power 1,79, Metallurgical Industries 1,25, Petroleum & Natural Gas 1,11, Chemical 1,01, The sectors receiving the largest shares of total FDI inflows up to August 2009 were the service sector and computer software and hardware sector, each accounting for and 9.48 percent respectively. These were followed by the telecommunications, real estate, construction and automobile sectors. The top sectors attracting FDI into India via M&A activity were manufacturing; information; and professional, scientific, and technical services. These sectors correspond closely with the sectors identified by the Indian government as attracting the largest shares of FDI inflows overall. The ASSOCHAM has revealed that FDI in Chemicals sector (other than fertilizers) registered maximum growth of 227 per cent during April 2008 March 2009 as compared to per cent during the last fiscal. The sector attracted USD 749 million FDI in FY 09 as compared to USD 229 million in FY 08. During the year 2009 government had raised the FDI limit in telecom sector from 49 per cent to 74 per, which has contributed to the robust growth of FDI. The telecom sector registered a growth of 103 per cent during fiscal as compared to previous fiscal. The sector attracted USD 2558 million FDI in FY 09 as compared to the USD 1261 million in FY 08, acquired 9.37 per cent share in total FDI inflow. Tolani Institute of Management Studies 15

16 India automobile sector has been able to record 70 per cent growth in foreign investment. The FDI inflow in automobile sector has increased from USD 675 million to 1,152 million in FY 09 over FY 08. The other sectors which registered growth in highest FDI inflow during April March 2009 were housing & real estate (28.55 per cent), computer software & hardware (18.94 per cent), construction activities including road & highways (16.35 per cent) and power (1.86 per cent). FOREIGN INSTITUTIONAL INVESTMENT Objective 2: Influence of FII on movement of Indian stock exchange during the post liberalization period that is September 2006 to September I. Introduction to FII Tolani Institute of Management Studies 16

17 Since , the Government of India embarked on liberalization and economic reforms with a view of bringing about rapid and substantial economic growth and move towards globalization of the economy. As a part of the reforms process, the Government under its New Industrial Policy revamped its foreign investment policy recognizing the growing importance of foreign direct investment as an instrument of technology transfer, augmentation of foreign exchange reserves and globalization of the Indian economy. Simultaneously, the Government, for the first time, permitted portfolio investments from abroad by foreign institutional investors in the Indian capital market. The entry of FIIs seems to be a follow up of the recommendation of the Narsimhan Committee Report on Financial System. While recommending their entry, the Committee, however did not elaborate on the objectives of the suggested policy. The committee only suggested that the capital market should be gradually opened up to foreign portfolio investments. From September 14, 1992 with suitable restrictions, FIIs were permitted to invest in all the 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. While presenting the Budget for , the then Finance Minister Dr. Manmohan Singh had announced a proposal to allow reputed foreign investors, such as Pension Funds etc., to invest in Indian capital market. II. Market design in India for foreign institutional investors Foreign Institutional Investors means an institution established or incorporated outside India which proposes to make investment in India in securities. A Working Group for Streamlining of the Procedures relating to FIIs, constituted in April, 2003, inter alia, recommended streamlining of SEBI registration procedure, and suggested that dual approval process of SEBI and RBI be changed to a single approval process of SEBI. This recommendation was implemented in December Currently, entities eligible to invest under the FII route are as follows: i) As FII: Overseas pension funds, mutual funds, investment trust, asset management company, nominee company, bank, institutional portfolio manager, university funds, endowments, foundations, charitable trusts, Tolani Institute of Management Studies 17

18 ii) charitable societies, a trustee or power of attorney holder incorporated or established outside India proposing to make proprietary investments or with no single investor holding more than 10 per cent of the shares or units of the fund. As Sub-accounts: The sub account is generally the underlying fund on whose behalf the FII invests. The following entities are eligible to be registered as sub-accounts, viz. partnership firms, private company, public company, pension fund, investment trust, and individuals. FIIs registered with SEBI fall under the following categories: a) Regular FIIs- those who are required to invest not less than 70 % of their investment in equity-related instruments and 30 % in non-equity instruments. b) 100 % debt-fund FIIs- those who are permitted to invest only in debt instruments. The Government guidelines for FII of 1992 allowed, inter-alia, entities such as asset management companies, nominee companies and incorporated/institutional portfolio managers or their power of attorney holders (providing discretionary and nondiscretionary portfolio management services) to be registered as FIIs. While the guidelines did not have a specific provision regarding clients, in the application form the details of clients on whose behalf investments were being made were sought. While granting registration to the FII, permission was also granted for making investments in the names of such clients. Asset management companies/portfolio managers are basically in the business of managing funds and investing them on behalf of their funds/clients. Hence, the intention of the guidelines was to allow these categories of investors to invest funds in India on behalf of their 'clients'. These 'clients' later came to be known as sub-accounts. The broad strategy consisted of having a wide variety of clients, including individuals, intermediated through institutional investors, who would be registered as FIIs in India. FIIs are eligible to purchase shares and convertible debentures issued by Indian companies under the Portfolio Investment Scheme. Tolani Institute of Management Studies 18

19 iii. Prohibitions on Investments: FIIs are not permitted to invest in equity issued by an Asset Reconstruction Company. They are also not allowed to invest in any company which is engaged or proposes to engage in the following activities: 1) Business of chit fund 2) Nidhi Company 3) Agricultural or plantation activities 4) Real estate business or construction of farm houses (real estate business does not include development of townships, construction of residential/commercial premises, roads or bridges). 5) Trading in Transferable Development Rights (TDRs). iv. Trends of Foreign Institutional Investments in India. Portfolio investments in India include investments in American Depository Receipts (ADRs)/ Global Depository Receipts (GDRs), Foreign Institutional Investments and investments in offshore funds. Before 1992, only Non-Resident Indians (NRIs) and Overseas Corporate Bodies were allowed to undertake portfolio investments in India. Thereafter, the Indian stock markets were opened up for direct participation by FIIs. They were allowed to invest in all the securities traded on the primary and the secondary market including the equity and other securities/instruments of companies listed/to be listed on stock exchanges in India. It can be observed from the table below that India is one of the preferred investment destinations for FIIs over the years. As of March 2009, there were 1609 FIIs registered with SEBI. SEBI Registered FIIs in India Year End of March Tolani Institute of Management Studies 19

20 v. FII trend in India Year Gross Gross Sales (b) Net % increase Purchases (a) (Rs. crore) (Rs.crore) Investment (a-b) in FII inflow (Rs. crore) Tolani Institute of Management Studies 20

21 There may be many other factors on which a stock index may depend i.e. Government policies, budgets, bullion market, inflation, economic and political condition of the country, FDI, Re./Dollar exchange rate etc. But for my study I have selected only one independent variable i.e. FII and dependent variable is indices of nifty. Tolani Institute of Management Studies 21

22 vi. Co relation with Indices Indices Co-relation with FII Sensex 0.80 Bankex 0.18 Power 0.33 IT 0.13 Capital Goods 0.44 From the above table we can say that FII has a positive impact on all the indices which means that if FIIs come in India then it is goods for the Indian economy. FIIs have more co-relation with Sensex so we can say that they are mostly invest in big and reputed companies which are included in Sensex. Power and Capital Goods sector have more co-relation with FII investment which shows more interest of FIIs in those sectors. Tolani Institute of Management Studies 22

23 vii. Hypothesis Test VAR00003 VAR00004 VAR00003 Pearson Correlation ** Sig. (2-tailed).000 N VAR00004 Pearson Correlation.801 ** 1 Sig. (2-tailed).000 N **. Correlation is significant at the 0.01 level (2-tailed). Here the correlation 0.8 which shows that both have positive relation if FII increase then Sensex will also increase. But if we compare the significance with the degree of freedom then null hypothesis is accepted because (0.00<0.01) so it shows that FIIs will have no significant impact on the Sensex. Tolani Institute of Management Studies 23

24 CONCLUSION Objective 1: A large number of changes that were introduced in the country s regulatory economic policies heralded the liberalization era of the FDI policy regime in India and brought about a structural breakthrough in the volume of the FDI inflows into the economy maintained a fluctuating and unsteady trend during the study period. It might be of interest to note that more than 50% of the total FDI inflows received by India during the period from came from Mauritius, Singapore and the USA. The main reason for higher levels of investment from Mauritius was that the fact that India entered into a double taxation avoidance agreement (DTAA) with Mauritius were protected from taxation in India. Among the different sectors, the service sector had received the larger proportion followed by computer software and hardware sector and telecommunication sector. Objective 2: According to findings and results, we have concluded that FII did have significant impact on Sensex but there is less co-relation with Bankex and IT. One of the reasons for high degree of any linear relation can also be due to the sample data. The data was taken on monthly basis. The data on daily basis can give more positive results (may be). Also FII is not the only factor affecting the stock indices. There are other major factors that influence the bourses in the stock market. Tolani Institute of Management Studies 24

25 BIBLIOGRAPHY Sites Tolani Institute of Management Studies 25