Impact of FIIs on Trading Quantity and Market Capitalization of Indian Stock Market

Transcription

1 7 Impact of FIIs on Trading Quantity and Market Capitalization of Indian Stock Market 7.1 Background For developing countries, foreign portfolio equity investment has different characteristics and implications compared to foreign direct investment (FDI). Besides supplementing domestic savings, FDI is expected to facilitate transfer of technology to introduce new management and marketing skills and to extend host country s markets and foreign trade. FPI, on the other hand, supplements foreign exchange availability and domestic savings but are not often project specific. Foreign institutional investments in the form of portfolio investments are welcome by the developing counties as this is non-debt creating. It is expected that FPI leads to improvement in the functioning of the stock markets, which in turn results into increased trading volume and market capitalization as foreign portfolio investors intend to invest on the basis of well-researched strategies and realistic stock valuation. Further, it is believed, foreign institutional flows could help on achieving a higher degree of liquidity at stock markets, to increase price earning (P/E) ratios and consequently to reduce cost of capital for investment. The lower cost of capital and booming stock market can encourage new equity issues. Foreign portfolio investments provide investors with an array of assets with varying degree of risk, return and liquidity. The increased choice of assets and existence of vibrant equity markets provides savers with more liquidity and options. The above in turn results in augmenting households savings directed towards stock markets. The liquid markets can improve the allocations of capital and can enhance prospects for long term economic growth. Generally, FIIs concentrate on secondary markets. A strong secondary market, besides providing liquidity to primary markets, allows the efficient

2 firms to price their new issues at a premium. Moreover, increased competition from foreign institutional investors also paves the way for the derivatives market. India faced debt crisis in the late 1980 s and the balance of payments crisis in These two problems led to the third one i.e. shortage of investible resources. All this compelled Indian government to initiate financial liberalization programme. Along with the series of these reforms, the foreign investments regime was also liberalized to a great extent. Lalitha (1992) states that attracting foreign capital appeared to be the main reason for opening up the stock markets for foreign institutional investors. In recent years, FIIs have displayed a strong appetite for India as shown in Table 7.1. This table indicates that FIIs net investments increased to 2432 million dollar in , but after the Asian crisis, these got a negative sign and stood at -386 million $. However, there has never been a looking back thereafter and FIIs net investment in India TABLE 7.1 FOREIGN PORTFOLIO INVESTMENTS IN INDIA (US $ MILLION) YEARS ADRs/GDRs FIIs Offshore Funds Total and Others ,520 1, , ,082 1, , , , ,366 2, , , , , , , , , , , ,950-10, , , ,552 9, ,

3 ,776 6, , * 2,785 15, ,391 Source: RBI Bulletin December 2007 *Data is upto September 2007 rose to million dollar in year Net investments went up further and were recorded at million dollar for the duration April 2007 to September GDRs/ADRs reached to US $ 2082 million in from 240 million in However, as the FIIs gained momentum in , GDRs/ADRs lost their signing and came down as low as 683 million US $ in this year. During the last 10 years, the funds flowing through this route (ADRs/GDRs) have fluctuated between 270 million to 831 million US $. The various forms of foreign portfolio investments combinedly worked out the lowest (US $ -57 million) in and the highest (US $ million) in we can note from the table under reference that India has succeeded in attracting constantly more than $ million of foreign capital in the form of portfolios investments in each of the last five years. The same is further supported by the share holding pattern as available in Table 7.2. Obviously, FIIs have snatched more than 10 percent share in total shareholding in case of majority of the industries in India. In some sectors such as banking, finance, media and entertainment FIIs hold more than 15 percent of the equity shares. However, their share in the equities of petrochemical, infrastructure and manufacturing sector is not so much encouraging. Based on the above theoretical framework it become imperative to investigate the influence of FIIs arrival on Indian stock market in general, and on its liquidity/turnover and market capitalization in particular. This chapter of our study is a step towards the same. More specifically, here an attempt has been made to analyze the Indian stock market development in terms of market capitalization, turnover, P/E ratio etc. since the opening of India s stock markets for FIIs participation. Beside, studying the role of FIIs in stock market development, the cause and effect relationship between volume, market capitalization and foreign portfolio investment has been determined. 7.2 Scope, Database and Methodology

4 This study covers a time period of 15 years from January 1993 to August 2007 so as to measure the impact of FIIs on trading volume and market capitalization of India s stock market. Monthly basis data of the Trading Volume and market capitalization have been taken from the website of the Reserve Bank of India to achieve the objective of work. We have taken the monthly data of the purchases and sales of securities by FIIs for the analysis. It needs mention that India witnessed multi-billion rupee stock market scam in March 2001, which led to a freeze on the flagship scheme of Indian largest mutual fund (Unit Trust of India) in June Resultantly, the market

5 TABLE 7.2: SHARE HOLDING PATTERN AT THE END OF MARCH 2007 IN INDIA (In percentage) Category Banks Venture Shares Indian Foreign Mutual Others Bodies /Financial FIIs Capital Individuals Others held by Promoters Promoter Funds Institution Corporate Inst./Govt Funds Custodians Banks Engineering Finance FMCG IT Infrastructure Manufacturing Media & Ent Petrochemicals Pharmaceuticals Services Telecom Miscellaneous % to total Shareholding Source: Indian Security Market A Review,

6 witnessed a considerable decline in trading volume at stock market. This abnormality could prompt any researcher to remove outlier and then measure the impact of FII investments on trading volume of Indian stock market. So we have ignored the time period from March 2001 to June 2001 in the calculation of the impact of foreign institutional investments on the Indian stock market s trading volume and market capitalization. However, it is not denied that stock market scams are results of system failure and hence these may re-occur. The development of stock market is a complex and multi-faced concept. There are various indicators of judging stock market development. One common used measure is the Value Traded Ratio (VR), which is total value of shares traded on a country s stock exchanges as a percent of GDP. The second measure is the value share traded as a percent of market capitalization. This turnover ratio (TR) measures the trading relative to the size of the stock market. The third indicator, the market capitalization (MR), which is market capitalization of listed shares in a stock exchange as a percent of GDP, measures the size and expansion of the market. The value traded and turnover ratios are considered as the indicators of liquidity. To measure the stock market development as aggregate index called SINDEX was constructed. The average of market capitalization ratio (MR), value traded ratio (VR) and turnover ratio (TR). [i.e.mr+tr+vr/3] has been taken as the SINDEX in our study. Moreover, the econometric technique namely Granger causality test has been followed to identify the existence of cause and effect relationship between FIIs investment and indicators of stock market development such as trading volume and market capitalization. As the trading volume and market capitalization are in the form of time series in our analysis, so there was a need to test the stationarity of these. Accordingly, we used the Augmented Dickey Fuller (ADF) test to test the stationarity of trading volume series, market capitalization series and monthly purchase and sales by foreign institutional investors by using the following equation: Y t = 1 + 2t+ Y t-1 + m i i=1 Y t-i + t (7.1) The dynamic linkage was examined by using the concept of Granger Causality Test. The following equations were used for the purpose. 130

7 Y t = 0 + n i=1 i X t-i + n i=1 i Y t-i + 1t (7.2) X t = 0 + n i=1 i Y t-i + n i=1 i X t-i + 2t (7.3) In the above equations Y t, X t are the variables to be tested and i, i, i i are coefficients explaining the relation of dependent variable with the lag terms of independent variable and lag terms of dependent variable in itself. 1t, 2t are mutually uncorrelated white noise errors. t is the time period and i is the number of lags. The null hypothesis is i,= I = 0. If i is statistically significant but I is not, it means X causes Y. In the reverse case Y causes X. But if both are significant then causality runs both ways. We have taken 2 lags as it is prescribed that 2 lags are sufficient to explain causality. Side by side, we also calculated the compound annual growth rate (CAGR) to measure the growth pattern of market after the introduction of foreign institutional investors by using the relative volume technique. Relative volume is calculated as the average of the market daily trading volume to the total market trading volume over the period taken into consideration. Here, we used the relative trading volume ratio rather than market s original trading volume data in order to capture the effect of other developments of the stock market on the trading volume. Moreover, trading volume tends to grow over time independent of the effect of the trading done by the foreign institutional investors due to various reasons like increasing awareness and public confidence in stock market etc. Mathematically, the relative volume is calculated as follows: 2 = Relative changes in regressand/ Absolute change in the regressor (7.4) Where 2 is the change in trading volume due to the time, regressand is the trading volume and regressor is the time, we can say 2 is that part of the trading volume which grows due to the time. It shows the instantaneous rate of growth. We have calculated the compound growth rate by taking the antilog of 2 and subtracting 1 from it and multiplying the difference by 100. Simultaneously, we have calculated the CAGR of market capitalization, number of companies listed, P/E ratio, BSE sensex and FII investments also. 131

8 7.3 Experiential Consequences At the outset, let us glance through Table 7.3 which presents month on month basis trend and progress of trading volume, market capitalization and FIIs net investment in Indian stock market since the introduction of the foreign institutional investors in September Although the doors of the Indian market were opened in the September 1992 for the entry of the FIIs, the actual flows started occurring in January Hence, Table 7.3 indicates month wise statistics from January 1993 to August 2007 on various aspects on foreign institutional investor s such as net investment, trading volume and market capitalization of BSE. It is evident from the table that during the first three years of their entry, the FIIs participated most actively in India s stock market in the month of January 1994 when their net investments rose as high as Rs crore, with increase of percent over the previous month. BSE s trading volume touched the psychological barrier of Rs crore the first time in December The similar behavior was repeated by the market in January 1994 when BSE s trading volume rose to Rs. 10,646 crore. It is disappointing to note that in next two and half year (e.g. till May 1996) trading volume could not reach again the level attained in January In the month of June 1996, the trading volume of BSE again crossed the level of Rs. 10,000 crore and rose to Rs. 12,041 crore. In the next very month, it went upto Rs. 14,863 crore. FIIs net investments, on the other hand, registered more than 300 percent growth merely in three months period from December 1995 to February The above mentioned robust growth phenomenon pertaining to both FII s investments and trading volume may particularly be attributed to the empowerment of SEBI to allow pension funds, mutual funds, AMCs, banks and institutional portfolio managers established or incorporated outside the India in November SEBI proposed to make investments in India on behalf of broad based funds to apply for FII status. Another interesting observation from the data given in Table 7.3 belongs to the pattern of market capitalization of Bombay Stock Exchange. Despite a lot of fluctuations pertaining to net investments of FIIs, the market capitalization of BSE kept on rising month by month till September 1995 when it rose to Rs. 530,819 crore. In next four months it declined around 20 percent. Mention of two important episode of alarming 132

9 fluctuations is essential here. These are: (a) the East Asian crisis in 1997 and (b) the Pokran nuclear explosion (May 2008). What is appreciable is the insignificant affect of these events on the behaviour of the foreign portfolio investors. We might note from Table 7.3 that net investments of FIIs are observed negative only in three months i.e. November, December and January during , the year of Asian crisis. Similarly, no significant affect is visible from this table on market capitalization and trading volume of BSE. During January 1996 to June 1999, the market capitalization of BSE was seen howering between Rs. 4.3 lakh crore to Rs lakh crore. However, it fluctuated between Rs. 6.5 lakh crore to 10.3 lakh crore during July 1999 to February There after, Indian stock market remained in depression upto April The stock market scam of early 2001 in India exerted adverse affect on BSE s market capitalization as well as trading volume for a long time (i.e. March 2001 to November 2001) along with FIIs inflows to Indian market. After a gap of three years, BSE s market capitalization again touched the level of Rs. 10 lakh crore in October Despite all odds like black Monday (May 2004), the market capitalization rose above Rs lakh crore in August TABLE 7.3: TREND OF THE TRADING VOLUME, MARKET CAPITALISATION AND FII INVESTMENTS DURING 1993 TO 2007 Year (1) FIIs Net Investments (Rs. Cr.) (2) % Change in FIIs Investments (3) BSE Trading Volume (Rs. Cr.) (4) % Change in BSE s trading Volume (5) BSE Market Capitalization (Rs. Cr.) (6) % Change in the BSE s Capitalization (7) Jan Feb Mar April May Jun Jul Aug

10 Sp Oct Nov Dec Jan Feb Mar April May Jun Jul Aug Sp Oct Nov Dec Jan Feb Mar April May Jun Jul Aug Sp Oct Nov Dec Jan Feb Mar April

11 May Jun Jul Aug Sp Oct Nov Dec Jan Feb Mar April May Jun Jul Aug Sp Oct Nov Dec Jan Feb Mar April May Jun Jul Aug Sp Oct Nov Dec

12 Jan Feb Mar April May Jun Jul Aug Sp Oct Nov Dec Jan Feb Mar April May Jun Jul Aug Sp Oct Nov Dec Jan Feb Mar April May Jun Jul Aug

13 Sp Oct Nov Dec Jan Feb Mar April May Jun Jul Aug Sp Oct Nov Dec Jan Feb Mar April May Jun Jul Aug Sp Oct Nov Dec Jan Feb Mar April

14 May Jun Jul Aug Sp Oct Nov Dec Jan Feb Mar April May Jun Jul Aug Sp Oct Nov Dec Jan Feb Mar April May Jun Jul Aug Sp Oct Nov Dec

15 Jan Feb Mar April May Jun Jul Aug Mean Std Devaition Skweness Kurtosis Jarque Bera Prob Most striking feature of Indian stock market is its all around growth which started taking place in April 2003 with the improvement in corporate and economic fundamentals. This growth continued upto August 2007 except a set back on May 2004 (Black Monday). Both trading volume and market capitalization of BSE registered approximately five times increase in the aforesaid period of four years and four months. The net investments by FIIs rose to Rs crore in October 2003 which touched next height of Rs crore in March However, in May 2006, the net investments observed a negative. sign with a decline of percent over the previous month. Probably, the above might have occurred in the midst of some bad news about poor performance of American economy. The BSE Sensex declined sharply which created a panic buying and selling activities by the investors. This gave a big blow to Indian stock market. The summary measures given in the end of the Table 7.3 indicates an average montly trading volume of Rs crore and market capitalization of Rs crore during the study period. Each series is found positively skewed. While the distribution of trading volume is mesokurtic, it is leptokurtic in case of market capitalization. Figures 7.1 and 7.2 also indicate that BSE trading volume and FIIs investments are moving in tandem 139

16 FIGURE 7.1: GROWTH OF BSE TRADING VOLUME OF BSE FROM 1993 TO 2007 FIGURE 7.2: GROWTH IN FIIs INVESTMENT IN INDIA FROM 1993 TO 2007 After analyzing month on month data regarding important indicators of stock market development since the arrival of FIIs, we have summarized the same data by transforming that into yearly statistics (Table 7.4). It is obvious from the table that the 140

17 TABLE 7.4: INDICATORS OF INDIAN STOCK MARKET DEELOPMENT AND Year Market Capitalization (Monthly Average in Rs. Crore) Gross Annual Turnover (Rs. Crore) GROWTH No. of Listed Companies FII Net Investment in India (Rs. Crore) BSE Sensex (Average of Daily Closing) P/E Ratio N.A. N.A , , , , , , , , , , , , , , * N.A. 56, Constant Growth Rate R-Square D.F F-value Significance Sources: Complied from SEBI Annual Report and Hand Book of Statistics and Security Market in India: A Review 2007 (published by NSE) *Data is upto August

18 market capitalization and market turnover have been increasing at a compound annual growth rate of percent and percent respectively. Similarly, CAGR of FIIs net investments and BSE Sensex are and 7.74 percent respectively. Hence, the liquidity has improved in the equity market because of the presence of FIIs. However, the average P/E ratio has declined at an annual rate of 5.02 percent. The number of listed companies indicated only 1.71 percent CAGR for the study period. From the above, it can be concluded that Indian stock market has grown phenomenally with the presence of FIIs Table 7.5 also indicates that the policy changes effected to stock markets in the form of permission to FIIs seems to have affected indicators of liquidity. On an average, the market capitalization ratio (MR) varies from 0.32 to 0.57 during to But, MR declined to 0.28 and 0.29 in and , respectively. The picture of recent four years i.e. from to is beautiful as the MR has climbed to as high as 0.87 in from 0.29 in In contrast to MR, the turnover ratio (TR) slipped to as low as 0.10 in from 0.32 in However, from to this ratio kept on touching new mile stone every year and rose to 1.41 in But, TR registered a down-ward trend in which continues till date. So far value traded ratio (VR) is concerned, it rose appreciably with the beginning of reforms in security market in The ratio was seen the highest in year This ratio has fluctuated in a narrow space during the last five years. Interestingly, SINDEX the combined indicator of market development used initially by Demirgue-Kunt and Kevine (1996) shows a constant improvement in the ratio from to But, VR declined considerably in and As a result of India shining story, the ratio has increased upward in the recent years. Thus, the trading volume as a share of national output is negligible in Indian context. After , although turnover, i.e. indicators of liquidity, has improved to a great extent, yet the ratio is not satisfactory. The number of shares being traded at stock markets in India is however not appreciable. The similar results have been drawn by Biwas (2005). Another aim of this study was to determine causal relationship between FIIs investments, trading volume, and market capitalization. As stated previously, Granger causality analysis is used for the purpose. Keeping in view the requirement of this model, 142

19 TABLE 7.5: GROWTH AND LIQUIDITY ON INDIAN STOCK MARKETS Year Value Traded Ratio (VR) 1 Market Capitalization Ratio (MR) 2 Turnover Ratio (TR) 3 4 SINDEX * N.A. N.A N.A. Sources: Calculated from Handbook of Statistics Notes 1: Value Traded Ratio is estimated by dividing the total traded value by the GDP 2: Market capitalization ratio is calculated by dividing market capitalization by the GDP 3: Turnover ratio is value of total shares traded divided by market capitalization 4: SINDEX: MR + VR + TR /3 the property of time series data such as stationarity was examined at the out set. The Augmented Dickey Fuller Unit Root test was applied to check whether the time series of variables such as trading volume, market capitalization and FII s investments are stationary. The results of it are given in Table 7.6. It is evident from the table that times series of each variable except the FIIs net investments and Market Capitalization are stationary at first difference. FIIs net 143

20 investments and Market Capitalization, both series are stationary at level. In order to make the data appropriate for the analysis, first we made all the series stationary at level by using the differencing technique. TABLE 7.6: RESULTS OF ADF UNIT ROOT TEST Variable Value at Level Value at First Difference FIIs Net Investment (.0007) (.0000) FIIs Purchase (.8154) (.0000) FIIs Sale (.6119) (.0000) Trading Volume (.1823) (.0000) Market Capitalization (.0001) (.0000) Table 7.7 presents the outcome of pair wise Granger causality test. The null hypothesis that trading volume does not cause net investment by FIIs is rejected at 5 percent level of significance. It implies that the net investment by foreign institutional TABLE 7.7: PAIR WISE GRANGER CAUSALITY TEST BETWEEN TRADING VOLUME, MARKET CAPITALISATION, FIIN, FIIP AND FIIS Null Hypothesis: F-Statistic Probability Trading Volume does not Granger Cause FIIN* FIIN does not Granger Cause Trading Volume FIIN does not Granger Cause Market Capitalization* Market Capitalization does not Granger Cause FIIN Trading Volume does not Granger Cause FIIP* FIIP does not Granger Cause Trading Volume

21 FIIP does not Granger Cause Market Capitalization * Market Capitalization does not Granger Cause FIIP* FIIS does not Granger Cause Trading Volume Trading Volume does not Granger Cause FIIS FIIS does not Granger Cause Market Capitalization * Market Capitalization does not Granger Cause FIIS* Rejected at 5 percent level of significance investors are influenced by the trading volume of BSE. However, the vice-versa is not true. That is, the FIIs net investments do not exert significant affect on trading volume of Indian stock market. In contrast, the findings of study by Tripathi (2007), the another hypothesis FIIN does not cause market capitalization is rejected and hence the market capitalization is dependent on foreign investor s net investments, significantly. Surprisingly, the other side of the assumption is found valid and accepted. So, FIIN is not affected by market capitalization The third hypothesis trading volume at BSE does not Granger cause total purchases by FIIs, is also rejected. Hence, purchase of securities at BSE is caused by trading volume of this market. The opposite of the above said hypothesis gets accepted at 5 percent level of significance. It means trading volume is not dependent on foreign institutional investments. The table under study further shows that market capitalization is influenced by purchases of FIIs at BSE. The similar is true with respect to the hypothesis market capitalization does not Granger cause FIIP. An another important revelation of the Table 7.7 is that neither sale by FIIs affects trading volume nor trading volume affects sales. However, sale by FIIs and market capitalization both have turned as significant determinants of each other. 145

22 7.4 References: Biswas, Jaideep (2005), Foreign Portfolio Investments (FPIs) and Stock Market Behaviour in A Liberalized Economy: An Indian Experience, The Asian Economic Review, August, Vol. 47, No.2. Demirgue-Kunt, Asli and Ross Levine (1996), Stock Market Development and Financial Intermediation; Stylished Facts, TWBER, May, Vol. 10 No.2. Dept. of Economic Affairs (2005), Report of the Expert Group on Encouraging FII Flows and Checking the Vulnerability of Capital Market to Speculative Flows, Ministry of Finance, Government of India, New Delhi, November. Dickey, D.A. and W.A. Fuller (1979), Distribution of the Estimation for Autoregressive Time series with a Unit Root, Journal of American Statistical Association, Vol.79, pp Granger, C.W.J. (1969), Investigating Causal Relations by Econometric Models and Cross-Spectral Methods, Econometrica, Vol.37, pp Lalitha, S. (1992), Failure to Woo Funds Forced Move on FIIs, Observer of Business and Politics, September, 16. Tripathi, N. P. (2007), Dynamic Relationship between Stock Market, Market Capitalization and Net FII Investment in India, ICFAI Journal of Applied Finance, August, pp