ABSTRACT:

An economy, apart from everything else, is a highly fluid transmission mechanism. Its beauty lies in how the smallest of changes have the most complex trickle-down effects. A paradigmatic example of how seemingly minor policy changes can jump start the economy can be illustrated by examining the effects of liberalization on capital market in India. The FIIs have been playing key role in the Indian capital market, since their entry in the early 1990s.

Globalization had led to widespread liberalization and implementation of financial market reforms in many countries, mainly focusing on integrating the financial markets with the global markets. Indian Capital Market has also undergone metamorphic reforms in the past few years. Every segment of Indian Capital Market viz primary and secondary markets, derivatives, institutional investment and market intermediation has experienced impact of these changes which has significantly improved the transparency, efficiency and integration of Indian market with the global markets. This is one of the prime reasons why the foreign portfolio investments have been increasingly flowing into the Indian markets. A significant part of these portfolio flows to India comes in the form of Foreign Institutional Investors(FIIs)investments , mostly in equities . Ever since the opening of the Indian equity markets to foreigners, FII net investments have steadily grown. Thus, we can see that there has been a consistent rise in the FII inflows in to the country. While the concerns such as FII pulling back their investments and the kind of destabilizing effect on the capital market in India are all well-placed, comparatively less attention have been paid so far to analyzing the FII flows data and understanding their key features. A proper understanding of the nature and determinants of these flows, however, is essential for a meaningful debate about their effects as well as predicting their chances of their sudden reversals. Thus this project aims at studying the role of these Institutional investors and its impact on the capital markets in India. This also aims to find out the various factors and determinants for their investments and also cite out scenarios where in these investments when pulled back by these FII could really effect the capital markets in India.

EXECUTIVE SUMMARY:
The objective of the project is to find the different role of institutional investors in the capital market in india and then to find the role of instittutional investors in the major volatile episode in the capital market in india.Finaly to find the relationship between the Sensex variation with the variation of the investments made by the institutional investors. India opened its stock markets to foreign investors in September 1992 and

has, since 1993, received considerable amount of portfolio foreigners in the form of Foreign Institutional Investor s

investment

from

(FII) investment in

equities. While it is generally held that portfolio flows benefit the economies of recipient countries, policy makers worldwide have been more than a little uneasy about such investments. Portfolio flows-often referred as hot money-are notoriously volatile compared to other types of capital inflows. Investors are known to pull back portfolio investments at the slightest hint of trouble in the host country often leading to disastrous consequences to its economy. They have been blamed for exacerbating small economic problems in a country by making large and concerted withdrawals at the first sign of economic weakness. The methodology used to is regression analysis. The degree of association helps us to quantify the relation ship between the variation in sensex due to the variation in the net investments made by the institutional investors. After completeing the project I could recommend that Government should certainly encourage foreign institutional investment but should keep a check on the volatility factor. Long term funds should be given priority and encouraged some of the actions that could be taken to ensure stability are Strengthening domestic institutional investors Operational flexibility to impart stability to the market Knowledge activities and research programs To conclude with I would say the that the foreign funds is certainly one of the most important cause of volatility in the Indian stock market and has had a considerable influence on it. Although it would not be fair enough to come to any conclusion as there are a lot of other factors beyond the scope of the study that effect returns and risks .it is not easy to predict the nature of the macroeconomic factors and their behavior but it has a great significance on any economy and its elements. Although generally a positive relation

has been seen between the stock market returns and the FII inflows it is not easy to say which is the cause n which is the effect.

INTRODUCTION:
Till 1980s Indian economy has remained quite closed towards the foreign investments but it was well realized by the government during 1990s that the foreign investment can play significant role to promote economic growth. It was the time when the wave of economic reforms also touched the capital market. The objective was all clear, i.e., to fasten the pulse of development in all economic activities. At the initial stages of reforms with regard to FIIs the credit can be given to the New Industrial Policy, 1991 framed by the government to focus on the importance of foreign direct investment in order to augment

technological updating in a globalized world. In order to give further push to foreign investment, Government of India permitted the portfolio investment made by foreign institutional investors in India. The initial guidelines regarding the flow of capital by FIIs was suggested by Narsimhan Committee Report on financial system of India. Figure 1 given below has showed the trend of number of FIIs and Net Investment made by them during last decade. The information of the same has been obtained through the report published by SEBI. The capital market of India was gradually opened for foreign institutional investors. They were allowed to invest in all traded securities on the primary market and secondary markets including various financial products, viz., shares, debentures and warrants etc. India has always been an attractive destination for foreign investors as Indian economy has always been a good performer among other Asian countries. But whenever a crisis has been identified on Indian capital market or a financial crisis occurring at world level, it has always impacted the capital flows by portfolio investors. Therefore continuous evidences are obtained by researchers indicating the volatility shifts on the stock market due to the behavior of foreign institutional investors.

OBJECTIVE OF THE PROJECT:

To Study the Role of Institutional Investors especially the FII on the capital market in India. To study the behavioral pattern of FII in India

LIMITATIONS OF THE STUDY:

The study has got all the limitations of using secondary data and the inferences were made on that.

METHODOLOGY:
For covering the Theoretical part I shall be going through a lot of literature including books on FII& Capital Market. Beyond this I shall be tracking the performance of FII through the help of internet. For the purpose of the project Secondary data were used.

TYPES OF INSTITUTIONAL INVESTORS:

5.1. DOMESTIC INSTITUTIONAL INVESTOR is used to denote an investor - mostly of the form of an institution or entity, which invests money in the financial markets of its own country where the institution or entity was originally incorporated. In India, there are broadly four types of institutional investors.

5.1.1 DEVELOPMENTAL FINANCIAL INSTITUTIONS like Industrial Finance Corporation of India (IFCI), Industrial Credit and Investment Corporation of India (ICICI), Industrial Development Bank of India (IDBI), the State Financial

Corporations, etc. The role played by these financial institutions (FIs) is to extend funds to the companies for both long term financing and (more recently) working capital financing. The financial institutions extend both debt and equity financing to their nominee directors in the companies. 5.1.2INSURANCE COMPANIES like the Life Insurance Corporation (LIC), General Insurance Corporation (GIC), and their subsidiaries. 5.1.3BANKS: Earlier banks used to finance only the working capital of the companies. But now they are also extending long-term finance to the companies. 5.1.4ASSET MANAGEMENT COMPANIES all the mutual funds including Unit Trust of India (UTI). The mutual funds collect funds from both individuals and corporate to invest in the financial assets of other companies. In India, the mutual funds participate largely in the equity capital of the companies. The mutual fund industry which is the major institutional investors in India started in 1963 with the formation of Unit Trust of India, at the initiative of the Government of India and Reserve Bank. The history of mutual funds in India can be broadly divided into four distinct phases First Phase: 1964-1987, Unit Trust of India (UTI) was established on 1963 by an Act of Parliament.

Second Phase : 1987- 1993, Entry of Public Sector Funds .1987 marked the entry of non- UTI, public sector mutual funds set up by public sector banks and Life Insurance Corporation of India(LIC) and General Insurance Corporation of India (GIC). Third Phase: 1993-2003, Entry of Private Sector Funds in 1993. Kothari Pioneer (now merged with Franklin Templeton) was the first private sector mutual fund registered in July 1993.As at the end of January 2003;there were 33 mutual funds with total assets of Rs. 1, 21,805 crores. The Unit Trust of India with Rs.44, 541 crores of assets under management was way ahead of other mutual funds. Fourth Phase: 2003-2007 In Feb 2003 the Unit Trust of India Act 1963 UTI was bifurcated into two separate entities. The Specified Undertaking of Unit Trust of India, functioning under an administrator and under the rules framed by Government of India. The second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and functions under the Mutual Fund Regulation

5.2 FOREIGN INSTITUTIONAL INVESTOR: The term Foreign Institutional Investor is defined by SEBI as under: "Means an institution established or incorporated outside India which proposes to make investment in India in securities. Provided that a domestic asset management company or domestic portfolio manager who manages funds raised or collected or brought from outside India for investment in India on behalf of a sub-account, shall be deemed to be a Foreign Institutional Investor." Foreign Investment refers to investments made by residents of a country in financial assets and production process of another country. Entities covered by the term FII include Overseas pension funds, mutual funds, investment trust, asset management company, nominee company, bank, institutional portfolio manager, university funds, endowments, foundations, charitable trusts, charitable societies etc.(fund having more than 20 investors with no single investor holding more than 10 per cent of the shares or units of the fund) (GOI (2005)). FIIs can invest their own funds as well as invest on behalf of their overseas clients registered as such with SEBI. These client accounts that the FII manages are known as sub-accounts. The term is used most commonly in India to refer to outside companies investing in the financial markets of India. International institutional investors must register with Securities & Exchange Board of India (SEBI) to participate in the market. One of the major market regulations pertaining to FII involves placing limits on FII ownership in Indian companies. They actually evaluate the shares and deposits in a portfolio. WHY FIIS REQUIRED? FIIs contribute to the foreign exchange inflow as the funds from multilateral finance institutions and FDI (Foreign direct investment) are insufficient. Following are the some advantages of FIIs. It lowers cost of capital, access to cheap global credit. It supplements domestic savings and investments. It leads to higher asset prices in the Indian market. And has also led to considerable amount of reforms in capital market and financial sector. INVESTMENTS BY FIIS

There are generally two ways to invest for FIIs. EQUITY INVESTMENT 100% investments could be in equity related instruments or up to 30% could be invested in debt instruments i.e.70 (Equity Instruments): 30 (Debt Instruments) 100% DEBT 100% investment has to be made in debt securities only EQUITY INVESTMENT ROUTE: In case of Equity route the FIIs can invest in the following instruments: A. Securities in the primary and secondary market including shares which are unlisted, listed or to be listed on a recognized stock exchange in India. B. Units of schemes floated by the Unit Trust of India and other domestic mutual funds, whether listed or not. C. Warrants 100% DEBT ROUTE: In case of Debt Route the FIIs can invest in the following instruments: A. Debentures (Non Convertible Debentures, Partly Convertible Debentures etc.) B. Bonds C. Dated government securities D. Treasury Bills E. Other Debt Market Instruments It should be noted that foreign companies and individuals are not be eligible to invest through the 100% debt route. HISTORY OF FII India opened its stock market to foreign investors in September 1992, and in 1993, received portfolio investment from foreigners in the form of foreign institutional investment in equities. This has become one of the main channels of FII in India for foreigners. Initially, there were terms and conditions which restricted many FIIs to invest in India. But in the course of time, in order to attract more investors, SEBI has simplified many terms such as: The ceiling for overall investment of FII was increased 24% of the paid up capital of Indian company. Allowed foreign individuals and hedge funds to directly register as FII.

 Investment in government securities was increased to US$5 billion. Simplified registration norms. PROCEDURE FOR REGISTRATION: The Procedure for registration of FII has been given by SEBI regulations. It states- no person shall buy, sell or otherwise deal in securities as a Foreign Institutional Investor unless he holds a certificate granted by the Board under these regulations. An application for grant of registration has to be made in Form A, the format of which is provided in the SEBI (FII) Regulations, 1995. THE ELIGIBILITY CRITERIA FOR APPLICANT SEEKING FII REGISTRATION IS AS FOLLOWS: Good track record, professional competence and financial soundness. Regulated by appropriate foreign regulatory authority in the same capacity/category where registration is sought from SEBI. Permission under the provisions of the Foreign Exchange Management Act, 1999 (FEMA) from the RBI. Legally permitted to invest in securities outside country or its incorporation/establishment. The applicant must be a fit and proper person. Local custodian and designated bank to route its transactions.

ELIGIBLE SECURITIES A FII can make investments only in the following types of securities: Securities in the primary and secondary markets including shares, debentures and warrants of unlisted, to- be-listed companies or companies listed on a recognized stock exchange. Units of schemes floated by domestic mutual funds including Unit Trust of India, whether listed on a recognized stock exchange or not, and units of scheme floated by a Collective Investment Scheme. Government Securities Derivatives traded on a recognized stock exchange like futures and options. FIIs can now invest in interest rate futures that were launched at the National Stock Exchange (NSE) on 31st August, 2009. Commercial paper. Security receipts

REGULATION RELATING TO FII OPERATION Investment by FIIs is regulated under SEBI (FII) Regulations, 1995 and Regulation 5(2) of FEMA Notification No.20 dated May 3, 2000. SEBI acts as the nodal point in the entire process of FII registration. FIIs are required to apply to SEBI in a common application form in duplicate. A copy of the application form is sent by SEBI to RBI along with their 'No Objection' so as to enable RBI to grant necessary permission under FEMA. RBI approval under FEMA enables a FII to buy/sell securities on stock exchanges and open foreign currency and Indian Rupee accounts with a designated bank branch. FIIs are required to allocate their investment between equity and debt instruments in the ratio of 70:30. However, it is also possible for an FII to declare itself a 100% debt FII in which case it can make its entire investment in debt instruments. All FIIs and their sub-accounts taken together cannot acquire more than 24% of the paid up capital of an Indian Company. Indian Companies can raise the above mentioned 24% ceiling to the Sectoral Cap / Statutory Ceiling as applicable by passing a resolution by its Board of Directors followed by passing a Special Resolution to that effect by its General Body. Further, in 2008 amendments were made to attract more foreign investors to register with SEBI, these amendments are: The definition of broad based fund under the regulations was substantially widened allowing several more sub accounts and FIIs to register with SEBI. Several new categories of registration viz. sovereign wealth funds, foreign individual, foreign corporate etc. were introduced, Registration once granted to foreign investors was made permanent without a need to apply for renewal from time to time thereby substantially reducing the administrative burden, Also the application fee for foreign investors applying for registration has recently been reduced by 50% for FIIs and sub accounts Also, institutional investors including FIIs and their sub-accounts have been allowed to undertake short-selling, lending and borrowing of Indian securities from February 1, 2008.

INDIAN CAPITAL MARKET:

The Bombay Stock Exchange(BSE) , which began formal trading in1875, is one of the oldest in Asia . Over the last decade , there has been a rapid change in the Indian securities market, both in primary as well as the secondary market . Advanced technology and online-based transactions have modernized the stock exchanges. In terms of the number of companies listed and total market capitalization, the Indian equity market is considered large relative to the countrys stage of economic development. Currently, there are 40 mutual funds ,out of which 33 are in the private sector and 7 are in the public sector. Mutual funds were opened to the private sector in 1992. Earlier, in 1987, banks were allowed to enter this business, breaking the monopoly of the Unit Trust of India(UTI), which maintains a dominant position. Before 1992, many factors obstructed the expansion of equity trading. Fresh capital issues were controlled through the Capital Issues Control Act. Trading practices were not transparent, and there was a large amount of insider trading. Recognizing the importance of increasing invest or protection, several measures were enacted to improve the fairness of the capital market. The Securities and Exchange Board of

India(SEBI) was established in 1988. There have been significant reforms in the regulation of the securities market since 1992 in conjunction with overall economic and financial reforms. In1992, the SEBI Act was enacted giving SEBI statutory status as a nap ex regulatory body. And a series of reforms was introduced to improve investor protection, automation of stock trading, integration of national markets, and efficiency of market operations. India has seen a tremendous change in the secondary market for equity. Among the processes that have already started and are soon to be fully implemented are electronic settlement trade and exchange-traded derivatives. Before 1995, markets in India used open out cry, a trading process in which traders shouted and hand signaled from within a pit. One major policy initiated by SEBI from1993involvedtheshiftofallexchangesto screen-based trading, motivated

primarily by the need for greater transparency. The first exchange to be based on an open electronic limit order book was the National Stock Exchange (NSE), which started trading debt instruments in June 1994 and equity in November 1994. In March 1995 ,BSE shifted from open out cry to a limit order book market. Before 1994, Indias stock markets were dominated by BSE . In other parts of the country, the financial industry did not have equal access to markets and was unable to participate informing prices compared with market participants in Mumbai (Bombay). As a result, the prices in markets outside Mumbai were often different from prices in Mumbai. These pricing errors limited order flow to these markets. Explicit nationwide connectivity and implicit movement toward one national market has changed this situation. NSE has established satellite communications which give all trading members of NSE equal access to the market. Similarly, BSE and the Delhi Stock Exchange are both expanding the number of trading terminals located all over the country. The arbitrages are eliminating pricing discrepancies between markets. The Indian capital market still faces many challenges if it is to promote more

efficient allocation and mobilization of capital in the economy.

First, market infrastructure has to be improved as it hinders the efficient flow of information and effective corporate governance. Second, the trading system has to be made more transparent. Third, India may need further integration of the national capital market through consolidation of stock exchanges. Fourth, the payment system has to be improved to better link the banking and securities industries. The capital market cannot thrive alone; it has to be integrated with the other segments of the financial system. The global trend is for the elimination of the traditional wall between banks and the securities market. Securities market development has to be supported by overall macroeconomic and financial sector environments. Further liberalization of interest rates, reduced fiscal deficits, fully market-based issuance of Government securities and a more competitive banking sector will help in the development of a sounder and a more efficient capital market in India.

INFLUENCE OF FII ON INDIAN MARKET Positive fundamentals combined with fast growing markets have made India an attractive destination for foreign institutional investors (FIIs). Portfolio investments brought in by FIIs have been the most dynamic source of capital to emerging markets in 1990s. At the same time there is unease over the volatility in foreign institutional investment flows and its impact on the stock market and the Indian economy. Apart from the impact they create on the market, their holdings will influence firm performance. For instance, when foreign institutional investors reduced their holdings in Dr. Reddys Lab by 7% to less than 18%, the company dropped from a high of around US$30 to the current level of below US$15. This 50% drop is apparently because of concerns about shrinking profit margins and financial performance. These instances made analysts to generally claim that foreign portfolio investment has a short term investment horizon. Growth is the only inclination for their investment. Some major impact of FII on stock market: They increased depth and breadth of the market. They played major role in expanding securities business. Their policy on focusing on fundamentals of share had caused efficient pricing of share. These impacts made the Indian stock market more attractive to FII & also domestic investors. The impact of FII is so high that whenever FII tend to withdraw the money from market, the domestic investors fearful and they also withdraw from market.

FIIs not only enhance competition in financial markets, but also improve the alignment of asset prices to fundamentals. FIIs in particular are known to have good information and low transaction costs. By aligning asset prices closer to fundamentals, they stabilize markets. In addition, a variety of FIIs with a variety of risk-return preferences also help in dampening volatility. C. IMPROVING CAPITAL MARKETS: FIIs as professional bodies of asset managers and financial analysts enhance competition and efficiency of financial markets. By increasing the availability of riskier long term capital for projects, and increasing firms incentives to supply more information about them, the FIIs can help in the process of economic development. D. IMPROVED CORPORATE GOVERNANCE: Good corporate governance is essential to overcome the principal-agent problem between share-holders and management. Information asymmetries and incomplete contracts between share-holders and management are at the root of the agency costs. Bad corporate governance makes equity finance a costly option. With boards often captured by managers or passive, ensuring the rights of shareholders is a problem that needs to be addressed efficiently in any economy. Incentives for shareholders to monitor firms and enforce their legal rights are limited and individuals with small share-holdings often do not address the issue since others can free-ride on their endeavor. FIIs constitute professional bodies of asset managers and financial analysts, who, by contributing to better understanding of firms operations, improve corporate governance. Among the four models of corporate control takeover or market control via equity, leveraged control or market control via debt, direct control via equity, and direct control via debt or relationship banking-the third model, which is known as corporate governance movement, has institutional investors at its core. In this third model, board representation is supplemented by direct contacts by institutional investors. NEGATIVE IMPACT: If we see the market trends of past few recent years it is quite evident

that Indian equity markets have become slaves of FIIs inflow and are dancing to their tune. And this dependence has to a great extent caused a lot of trouble for the Indian economy. Some of the factors are: A. POTENTIAL CAPITAL OUTFLOWS: Hot money refers to funds that are controlled by investors who actively seek short-term returns. These investors scan the market for short-term, high interest rate investment opportunities. Hot money can have economic and financial repercussions on countries and banks. When money is injected into a country, the exchange rate for the country gaining the money strengthens, while the exchange rate for the country losing the money weakens. If money is withdrawn on short notice, the banking institution will experience a shortage of funds. B. INFLATION: Huge amounts of FII fund inflow into the country creates a lot of demand for rupee, and the RBI pumps the amount of Rupee in the market as a result of demand created. This situation leads to excess liquidity thereby leading to inflation where too much money chases too few goods. C. PROBLEM TO SMALL INVESTORS: The FIIs profit from investing in emerging financial stock markets. If the cap on FII is high then they can bring in huge amounts of funds in the countrys stock markets and thus have great influence on the way the stock markets behaves, going up or down. The FII buying pushes the stocks up and their selling shows the stock market the downward path. This creates problems for the small retail investor, whose fortunes get driven by the actions of the large FIIs. D. ADVERSE IMPACT ON EXPORTS: FII flows leading to appreciation of the currency may lead to the exports industry becoming uncompetitive due to the appreciation of the rupee. BSE SENSEX AND FII INVESTMENT CORRELATION Sensex is the commonly used name for the Bombay Stock Exchange Sensitive Index an index Composed of 30 of the largest and most actively traded stocks on the Bombay Stock Exchange (BSE). The term FII is used most commonly in India to refer to outside companies investing in the financial markets of India. FII investment is frequently referred to as hot money for the reason that it can leave the country at the same speed at which it comes in. In country like India; statutory agencies like SEBI have prescribed norms to register FIIs and also to regulate such investment flowing in through Fii

Date
03-Sep-13 02-Sep-13

Gross Purchase(Cr)
2,078.70 2,516.20

Gross Sale(Cr)
2,805.00 2,014.40

Net Investment(Cr)
-726.30 501.80

Cummulative Investment($Mn)
-108.59 76.19

FII Activity for the Year so far Month

January 2013 February 2013 March 2013 April 2013 May 2013 June 2013 July 2013 August 2013 September 2013

Gross Purchase (Cr)

77,858.80 78,888.30 66,766.60 61,007.30 74,468.90 55,321.40 60,371.00 69,308.40 11,011.80

Gross Sale (Cr)

55,799.80 54,449.10 57,642.70 55,593.10 52,300.40 66,348.50 66,624.20 75,231.10 11,336.40

Net Investment (Cr)

22,059.20 24,439.30 9,124.30 5,414.10 22,168.60 -11,026.90 -6,253.30 -5,922.50 -324.60

Cummulative Investment ($Mn)

4,059.32 4,575.56 1,675.48 1,000.27 4,067.42 -1,852.15 -1,042.88 -902.51 -47.44

FII Activity for previous years Year

2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000

Gross Purchase (Cr)

669,184.40 611,055.60 766,283.20 624,239.70 721,607.00 814,877.90 475,624.90 286,021.40 185,672.00 94,412.00 46,479.10 51,761.20 74,791.50

Gross Sale (Cr)

540,823.90 613,770.80 633,017.10 540,814.70 774,594.30 743,392.00 439,084.10 238,840.90 146,706.80 63,953.50 42,849.80 38,651.00 68,421.60

Net Investment (Cr)

128,360.70 -2,714.20 133,266.80 83,424.20 -52,987.40 71,486.30 36,540.20 47,181.90 38,965.80 30,459.00 3,629.60 13,128.20 6,370.08

Cummulative Investment ($Mn)

24,372.19 -357.83 29,361.83 17,458.14 -11,974.30 17,655.80 8,107.00 10,706.30 8,669.80 6,627.60 749.50 2,806.40 1,532.60