RelationshipbetweenFDI,FIIand

CapitalMarkets:
AnempiricalinvestigationforIndianeconomy
INPARTIALFULFILMENTOFTHEREQUIREMENTSFOR

MastersofScienceinFinance(M.Sc.Finance)
(TwoYearsFulltime)DegreeCourse20142016

ROLLNO:14MF01

UniversityofMumbai
JamnalalBajajInstituteofManagementStudies

Acknowledgement
This report is a culmination of my efforts during fourth semester of Master of
Science in finance course at JBIMS, Mumbai. This project has been a great
learning experience for me and I have been ably guided and supported in my
endeavor by many people.
I would like to extend my heart-felt gratitude to my guide for his support and help
during the course of the entire period. This project would not have been possible
without his guidance. I really appreciate his effort while helping me to make this
project report, which I believe, has enhanced my knowledge by applying the skills
on the topic I had chosen. I gratefully thank The Director, JBIMS for giving me an
opportunity to undertake such a useful thesis. I am also thankful to the respectable
faculty members at JBIMS for their teachings and thorough concept building in
various managerial disciplines, which helped a lot during the course of this project.

TABLEOFCONTENTS
Sr. No.

Particulars

Page

Executive Summary

Introduction of the
Topic
Literature Review

12

Trends

15

Research &
Methodology

19

Data Analysis

28

Model Validation

43

Conclusion

46

References

47

LISTOFFIGURE&CHARTS
Sr. No.

Title

Figure 1
Table 1
Table 2
Table 3
Table 4
Table 5
Table 6
Table 7

FII Flows to Emerging Markets

Balance of Payments -Indicators
Capital Account Data
Exports, Imports and Trade Balance
Dickey - Fuller Test
BIC Criteria
Granger Causality Test
Foreign Investment Inflows

Table 8

Pearson Correlation Coefficient

Table 9
Table 10
Table 11
Table 12

Regression Statistics - SENSEX

MultiCollinearity Statistics
Regression Statistics - NIFTY
MultiCollinearity Statistics

Table 13

Regression Statistics - EXP,FDI

Table 14

Regression Statistics - IMP,FDI

1.EXECUTIVESUMMARY
Foreign institutional investment signifies investments made by individual investors
or companies in foreign lands. India has been witnessing a surge in FII activity
since the opening of its capital markets. Owing to its high growth potential, India
has become a favorite destination for FII activity. FIIs, convinced of Indias
economic progress and strong corporate earnings, are continuously investing in
the country. Fast GDP growth has made India a preferred destination for foreign
investors post the 2008 financial crisis. This project analyses the role ahead for the
Foreign Institutional investors in the present Indian economic Scenario with the
focus on the impact on the Indian Capital Markets. The relationship between BSE
SENSEX, CNX Nifty and Foreign Investment in India is investigated using
statistical measures correlation and regression analysis. Sensex and CNX Nifty
were considered as the representative of stock market as they are the most
popular Indian stock market indices. Based on 6 years data starting from 2010 to
2015, it was found that the flow of FDI & FII was moving in tandem with Sensex
and Nifty. The Granger causality test findings indicate that the causality between
FII and BSE SENSEX is uni-directional. The results are purely based on secondary

data. The analysis was made through the application of Karl Pearson's coefficient
of Correlation and Multiple Regression. The study concludes that Flow of FDIs and
FIIs in India determines the trend of Indian stock market with R square values of .
606 and the impact of FDI is more important in case of NIFTY with R square values
of .6072.

Though, the FDI is a significant factor for all outcome variables yet its impact on
CNX Nifty has been greater than other outcomes; and the aggregate impact of all
the predictors jointly showed more impact on CNX Nifty than other outcome
variables. It was further indicated through the results that if all the two selected
independent factors remain constant, then also there are other factors as well,
which explain CNX Nifty and BSE SENSEX up to1649.480 and 2336.893 units.
Furthermore, the analysis of FDI and international trade components (Exports and
Imports), which are the major constituents of current account, supports the results
of granger causality. The results revealed that the regression analysis provide
useful mean for the impact of foreign investment on the capital markets in the
country.

2.INTRODUCTION
Unprecedented globalizations have witnessed double-digit economic growth
resulting in fierce competition and accelerated pace of innovation. As a result
inflow of Foreign Direct investments has become a striking measure of economic
development in both developed and developing countries. FDI and FII thus have
become instruments of international economic integration and stimulation. Fast
growing economies like Singapore, China, and Korea etc. have registered
incredible growth at onset of FDI. Though US capture most of the FDI inflows,
developing countries still account for significant growth of FDI and rise in FII. FDI
not only gives access to foreign capital but also provides domestic counties with
cutting edge technology, desired skill sets, tools of innovation and other
complementary skills. Apart from helping in creating additional economic activity
and

generating

employment,

foreign

investment

also

facilitates

flow

of

sophisticated technology into the country and helps the industry to march into

advanced technology. A favorable business environment fostered Indian economy

after 1991, when the government of India opened the door for foreign capital in the
way of direct investment and through foreign institutional investors. The policies
drafted to stimulate the flow of foreign capital in to India provided much needed
impetus for India to emerge as an attractive destination for foreign investors.
Consequently, the international capital inflows have been increased tremendously
during last two decades. Global foreign direct investment (FDI) flows rose by 36
per cent in 2015, reaching their highest levels since the financial crisis, according
to a report from the United Nations According to the report, developing economies
saw their FDI reaching a new high of $741 billion, five per cent higher than in 2014.
Developing Asia, with its flows surpassing half a trillion dollars, remained the
largest FDI recipient region in the world, accounting for one third of global FDI
flows. In first half of the 2015, India attracted investment of $31 billion compared to
$28 billion and $27 billion of China and the US respectively.

Fig 1. FII Flows to Emerging Markets

Foreign investors have invested Rs 6,460 crore (US$1.45 billion) in Indian stock
markets in just five trading sessions of July 2011.In the first six months of 2011,
overseas investors infused around Rs 17,000 crore (US$3.82 billion) into the
Indian market, including stocks and bonds. In the same period, FIIs made
investments of Rs 9,948 crore (US$2.23 billion) in the debt market, with
investments in stocks being Rs 2,670 crore (US$ 599.79 million).
Any investment that flows from one country into another is known as foreign
investment. Inflow of investment from other countries is encouraged since it
complements and stimulates domestic investments in capital-scarce economies of
developing countries. Since 1991 Foreign investments in the country are allowed
to take the form of investments (through stock market) in listed companies referred
as FII investments and investments in listed/unlisted companies other than through
stock exchanges are referred as Foreign Direct Investment. In other words FDI

refers to an investment made by a company based in one country, into a company

based in another country; companies making such direct investments have a
significant degree of influence and control over the company into which the
investment is made.
FDI is preferred over FII investments as it is considered to be the most beneficial
form of foreign investment for the economy as a whole. Direct investment targets a
specific enterprise, with the aim of increasing its capacity/productivity or changing
its management control.
Direct investment in order to create or augment capacity ensures that the capital
inflow gets translated into additional production. In the case of FII investment that
flows into the secondary market, the effect is to increase capital availability in
general, rather than availability of capital to a particular enterprise. Translating an
FII inflow into increased production depends on production decisions of the local
investor who has to explore and design production plans drawn upon the additional
capital made available via FII inflows to augment production. For instance, when
FDI flows into an enterprise for mere acquisition an existing asset, no addition to
production capacity takes place as the direct effect of FDI inflow. Thus, like in the
case of FII inflows, in this case too, addition to production capacity does not merely
result from the action of the foreign investor but on designs and actions of the
domestic seller who has to invest the proceeds of the sale in a manner that
augments capacity or productivity for the foreign capital inflow to boost domestic
production. There is a widespread notion that FII inflows are hot money it comes
and goes, creating volatility in the stock market and exchange rates. While this
might be true of individual funds, cumulatively, FII inflows have only provided net

inflows of capital.
FDI tends to be much more stable than FII inflows. Moreover, FDI brings not just
capital but also better management and governance practices and, often,
technology transfer. Prominently, the know-how that gets transferred along with
FDI is often more crucial and significant than the capital itself. Though no such
irreplaceable benefits accrue in the case of FII inflows, the search by FIIs for
credible investment options has improved accounting and governance practices
among many listed Indian companies.
Foreign investment is also seen as an emerging measure of growing economic
globalization. Investment has always been an issue for the developing economies
such as India and so those countries has drafted measures to liberalize their
policies for welcoming investment from countries that are abundant in capital
resources. The countries, which are developed, are focusing on new markets
where there is availability of abundant labors, scope for products, and high profits
are achieved to fulfill their growth ambitions.

Need for FDI & FII in India:

Growing India needs abundant foreign capital in the form of FDI & FII for the
development of basic infrastructure like Roads, Railways, Sea Ports, Warehouses,
Banking Services and Insurance Services etc. Moreover, rapid industrialization
since 1991 has further strengthened the need of foreign capital across various
industries. Many developing countries suffer from severe scarcity of funds in highly

capital-intensive areas such as infrastructure. This problem can be diverted to the

foreign capitalists by allowing them to invest. Other words, foreign capital are the
panacea for the scarcity of all resources.
The variations in the cost of capital are also one of the important factors resulting
in attracting foreign capital in India. For example, Interest rates are high in India as
compared to developed economies. In several countries the interest rates are as
low as 1% to 3%, where as in some countries like India the interest rates are very
high as 8% to 10% per annum. Thus, for enterprises in India, foreign capital is an
easy route to reduce the cost of capital. Thus investors tend to invest in countries
like India where they can gain maximum return on their investments. Gradual
Integration of global financial markets ultimately results in explosive growth of FDI
around the globe.

3.LITERATUREREVIEW
A study conducted by the World Bank in 1997 reports that stock market liquidity

improved in those emerging economies that received higher foreign investments.

John Andreas in his work The Effects of FDI Inflows on Host Country Economic
Growth discusses the potential of FDI inflows to affect host country economic
growth. The paper argues that FDI should have a positive effect on economic
growth as a result of technology spillovers and physical capital inflows. A cross
section and panel data analysis on a dataset covering 90 countries during the
period 1980 to 2002, finds that FDI inflows enhance economic growth in
developing economies only but not in developed economies. This paper has
assumed that the direction of causality goes from inflow of FDI to host country
economic growth. However, economic growth could itself cause an increase in FDI
inflows. Economic growth increases the market size of the host country market and
strengthens the incentives for market seeking FDI. This could result in a situation
where FDI and economic growth are mutually supporting. However, for the ease of
most of the developing economies growth is unlikely to result in market seeking
FDI due to the low income levels. Therefore, causality is primarily expected to run
from FDI inflows to economic growth for these economies.
According to Dornbusch and Park (1995), foreign investors pursue a positive
feedback strategy, which makes stocks to overreact to change in fundamentals.
Nitin Kansal examined the Impact of FDI & FII on India. The objective of his
research is to find the trends & patterns in the FDI from different countries flown
into India during 1991-2007 period means i.e. during post liberalization period &
Influence of FII on movement of Indian stock exchange during the post
liberalization period that is 1991to 2007. It concludes that FDI did have high

significant impact on the Indian capital market.

Chopra examines the effect of policy reforms on the FDI in India. The analysis has
been carried out with the help of annual data from 1980-2000. The research
includes policy related variables such as the degree of openness of the economy,
debt-service ratio, foreign exchange rate and GDP as the explanatory variables of
FDI inflows in India. Empirical result shows that GDP is an important factor which
motivates FDI in the country.
A research by Bohn and Tesar (1996) and Brennan and Cao (1997) based on
quarterly data of US investments on foreign equity markets found a positive
correlation of these flows and local returns on majority of the sample countries. In
order to investigate whether FDI announcements provide information to investors,
Ding & Sun (1997) studied whether shareholder benefits were a product of their
firms FDI decisions, and whether abnormal returns were attainable by trading
shares. Their results showed that investors buying and holding the stock of an
announcing firm 21 days around the announcement date could observe an
average 2.73% additional return.
Jayachandran and Seilan investigate the relationship between trade, Foreign
Direct Investment (FDI) and economic growth of India over the period 1970-2007.
The results of Granger causality test show that there is a causal relationship
between the examined variables. The direction of causality relationship is from
FDIs to growth rate and there is no causality relationship from growth rates to
FDIs. Most of empirical studies carried out in the past used multi regression model
to study the impact of flow of FDI & FII.

According to Morgan Stanley report FIIs strongly influence short-term market

movements during bear markets. However, the correlation between returns and
flows reduces during bull markets as other market participants raise their
involvement reducing the influence of FIIs. Research by Morgan Stanley shows
that the correlation between foreign inflows and market returns is high during bear
and weakens with strengthening equity prices due to increased participation by
other players.

4.TRENDSOFFOREIGNINVESTMENT

The economic reforms in India shifted the focus from import substitution to export
promotion strategy to enhance foreign trade. Indias BoP position improved
significantly after 2001 due to high foreign investment inflows. The improved
position of BoP is attributable to the huge amount of foreign investment flowing into
India causing a positive impact on capital account and resulting in overall BoP
position positive. The Balance of Payments account consists of two components:
(1) Current Account and (2) Capital Account.

BALANCE OF PAYMENTS - INDICATORS

(Per cent)

Current Account

Capital Account

Year
Current
Receipts/
GDP

Current
Current
Receipts/
Account
Current
Balance /GDP
Payments

Foreign
Investment/
Exports

Foreign
Investment/
GDP

2014-15

27.0

95.1

-1.4

23.8

3.7

2013-14

29.4

94.3

-1.7

11.2

1.9

2012-13

28.9

85.7

-4.8

17.8

3.0

2011-12

28.7

87.0

-4.2

16.3

2.7

2010-11

26.1

90.2

-2.8

23.6

3.5

2009-10

25.3

89.9

-2.8

35.9

4.8

2008-09

29.1

92.6

-2.3

14.8

2.3

2007-08

25.4

95.0

-1.3

37.3

5.0

2006-07

25.6

96.0

-1.0

23.1

3.1

2005-06

23.3

94.8

-1.2

20.3

2.6

2004-05

21.4

98.0

-0.3

18.0

2.1

2003-04

19.9

112.8

2.3

23.7

2.6

2002-03

18.8

106.6

1.3

11.2

1.2

2001-02

16.9

103.8

0.7

18.2

1.7

2000-01

16.8

96.4

-0.6

14.9

1.5

1999-00

15.0

93.0

-1.0

13.8

1.2

1998-99

14.4

93.2

-1.0

7.0

0.6

1997-98

14.2

90.9

-1.3

15.1

1.3

1996-97

14.2

91.6

-1.2

18.0

1.6

1995-96

13.9

88.8

-1.7

14.9

1.3

1994-95

13.0

91.7

-1.0

18.3

1.5

1993-94

12.2

95.6

-0.4

18.7

1.5

1992-93

11.3

87.7

-1.4

3.0

0.2

1991-92

10.2

94.3

-0.4

0.7

0.0

1990-91

8.0

71.5

-3.0

0.6

0.0

The Capital Account includes the following: (1) foreign investment (foreign direct
investment and foreign portfolio investment), (2) net external assistance, (3) net
commercial borrowings, (4) rupee debt service, (5) non-resident deposits, and (6)
other capital

The capital account of India has shown a rising trend since 1990 as shown in Table
3.In the initial years the major part of capital account was in the form of external
assistance and commercial borrowings but the trend changed after 1993-1994
when foreign investment became the major component of capital account. There is
a substantial decline in 2008-2009, which can be due to the global meltdown.
Foreign direct investment in India has shown a rising trend from 2000-01,
increasing substantially after 2005-06.
(Rupees Billion)

Year / Item

Capital account
(A to F)

A) Foreign
Investment

B) External
assistance, net

C) Commercial
borrowings, net

D) Rupee debt
service

E) NRI deposits,
F) Other capital
net

2014-15

5479.74

4605.30

126.23

85.00

-4.89

861.25

-193.15

2013-14

2838.04

2179.33

74.00

661.28

-3.04

2380.00

-2453.52

2012-13

5003.13

2982.05

68.82

466.07

-3.13

806.51

682.81

2011-12

3074.70

2417.06

120.55

420.99

-3.81

582.41

-462.51

2010-11

2791.05

2770.38

225.96

539.44

-3.10

148.20

-889.84

2009-10

2439.35

3117.04

153.59

119.71

-4.51

142.43

-1088.91

2008-09

305.15

1264.49

131.39

309.42

-4.72

204.30

-1599.73

2007-08

4331.67

2493.89

84.84

912.12

-4.92

7.05

838.70

2006-07

2080.17

1342.82

80.27

738.89

-7.25

195.74

-270.30

2005-06

1096.33

948.14

78.76

116.10

-25.57

124.57

-145.67

2004-05

1280.81

683.66

89.93

241.49

-18.58

-44.39

328.70

2003-04

800.10

717.28

-125.53

-132.74

-17.56

168.69

189.96

2002-03

513.77

290.72

-148.63

-82.63

-23.06

144.24

333.13

2001-02

401.67

388.61

58.19

-75.43

-24.57

131.27

-76.40

2000-01

392.41

310.16

20.80

201.94

-27.60

105.61

-218.50

1999-00

481.01

225.01

39.15

13.60

-30.59

67.09

166.75

1998-99

350.34

101.69

34.84

185.57

-33.08

40.59

20.72

1997-98

375.36

199.61

34.63

145.58

-27.84

43.25

-19.87

1996-97

405.02

218.28

39.97

100.03

-25.42

118.94

-46.81

1995-96

155.96

163.12

33.57

45.49

-31.05

38.22

-93.34

1994-95

287.43

154.50

47.99

32.39

-30.90

5.39

78.11

1993-94

304.15

132.82

59.63

19.04

-33.02

37.80

87.86

1992-93

118.83

16.99

57.48

-10.95

-23.35

60.97

17.68

1991-92

95.09

3.39

73.95

38.06

-27.85

10.07

-2.56

1990-91

128.95

1.84

39.65

40.34

-21.40

27.56

40.96

The following table contains the data of the overall imports and exports of major
commodities of India from 2000 to 2015.
I.

I.

Merchandise

Merchandise

I. Trade
Year /

balance
Item

- A) Exports,

- B) Imports,
(A-B)

2014-15
2013-14
2012-13
2011-12
2010-11
2009-10
2008-09
2007-08
2006-07
2005-06
2004-05
2003-04
2002-03
2001-02
2000-01

f.o.b.
19350.64
19310.74
16676.90
14825.17
11656.65
8632.82
8579.60
6680.08
5828.71
4657.48
3817.85
3039.15
2600.79
2133.45
2078.52

c.i.f.
28164.75
28159.18
27321.46
23946.47
17461.35
14232.48
14054.09
10356.73
8628.33
6954.12
5335.50
3673.01
3117.76
2683.00
2645.89

-8814.11
-8848.45
-10644.56
-9121.29
-5804.70
-5599.65
-5474.49
-3676.64
-2799.62
-2296.64
-1517.65
-633.86
-516.97
-549.55
-567.37

5.RESEARCH&METHODOLOGY
5.1 Data Collection

Data is obtained from Handbook of statistics on Indian Economy (various issues)

by Reserve Bank of India, publications from Ministry of Commerce, Govt. of India.
And various issues of FDI Fact Sheet published by Department of Industrial Policy
and Promotion.
The Sensex and CNX Nifty data is down loaded from the websites of Bombay
stock exchange and National stock exchange respectively.
To analyze the data, the statistical tools such as correlation and regression
analysis are used. Correlation coefficient is a statistical measure that determines
the degree to which two variable's movements are associated. Correlation
coefficient value ranges from -1to 1. Negative value of correlation indicates: if one
variable increases in its values, the other variable decreases in its value and
positive value indicates: if one variable increases in its values the other variable
also increases in its value. In the current study to know the linear relationship
between variables such as FDI & SENSEX, FDI & CNX nifty, FII & SENSEX and
FII & CNX Nifty correlation is applied. The regression analysis is a statistical
technique used to evaluate the effects of an independent variable on another
dependent variable. In the current report attempt is made to study the impact of
FDI & FII on SENSEX & FDI & FII on CNX nifty. So FDI & FII are considered as
independent variables and SENSEX & CNX Nifty as the dependent variable for
model.
To examine the causality between FDI and NIFTY, granger causality tests have
been used. Since conventional F- test gives spurious results if the data is not
stationary (Toda and Yamamoto, 1995; Yamada and Toda, 1998), I have used

MWald granger no causality test in Vector Auto Regressive (VAR) framework.

5.2 Model Description
Further, to study the impact of Foreign Direct Investment & Foreign Institutional
Investment on Indian stock market, model is farmed and fitted; it depicts SENSEX
and CNX Nifty as dependent variables; whereas independent variables are FDI &
FII.
1.

a) Y (SENSEX) = a + b1 X1(FDI) + b2 X2 (FII)

2.

b) Y (CNX Nifty)=a+b1X1 (FDI)+b2 X2 (FII)

Hypothesis
The null hypothesis for above models is; b1=0 & b2=0 against the alternative
hypothesis i.e. b1#0 & b2#0. It can be stated for model a & b as follows:
Model (a)
H01: FDI & FII has no significant impact on BSE Sensex movements. Ha1: FDI or
FII has significant impact on BSE Sensex movements.
Model (b)
H01: FDI& FII has no significant impact on Nifty movements. Ha1: FDI or FII has
significant impact on Nifty movements.
5.3 Statistical Tests
Testing the stationary properties

I employed Augmented Dickey Fullar (ADF) Test to figure out the stationary
properties of the series. The critical value of ADF is provided by MacKinnon. The
null hypothesis of unit root test is that series are non stationary or contain a unit
root.
The regression equation for FDI for unit root is given by
FDIt = FDIt-1 + 1FDIt-1 + 2FDIt-2 +.........+ pFDIt-p
Where FDI is the first difference of FDI
The test of unit root is conducted on the coefficient of FDIt-1. If the beta values are
significantly different from zero, then we reject the null hypothesis that FDI contains
unit root.
Similarly for FII, can be given as,
FIIt = FIIt-1 + 1FIIt-1 + 2FIIt-2 +.........+ pFIIt-p
Where FII is the first difference of FII
Summary statistics:
Variable
FDI INFLOWS

Observations
72

Obs. with missing

data

Obs. without
missing data
0

Minimum Maximum Mean

72

4725

126823

14570.8

Std. dev
15391

Dickey-Fuller test (ADF (stationary) / k: 4 / FDI INFLOWS)

Tau (Observed value)

-4.305

Tau (Critical value)

p-value (one-tailed)
alpha

-0.725
0.005
0.05

Test interpretation:
H0: There is a unit root for the series.
Ha: There is no unit root for the series. The series is stationary.
As the computed p-value is lower than the significance level alpha=0.05, one
should reject the null hypothesis H0, and accept the alternative hypothesis Ha.

The risk to reject the null hypothesis H0 while it is true is lower than 0.46%.

Time step / FDI INFLOWS

140000
120000
100000
80000

FDI INFLOW S

60000
40000
20000
0
0

10

20

30

40

Time step

50

60

70

80

Obs. with
Obs. without
Variable Observations missing
Minimum
missing data
data
FII
72
0
72 40902.5

Maximum
40757.29

Mean
10971.797

Std. deviation
15415.263

Dickey-Fuller test (ADF (stationary) / k: 4 / FII):

Tau (Observed value)

Tau (Critical value)
p-value (one-tailed)
alpha

-3.176
-0.725
0.088
0.05

H0: There is a unit root for the series.

Ha: There is no unit root for the series. The series is stationary.
As the computed p-value is greater than the significance level alpha=0.05, one
cannot reject the null hypothesis H0. The risk to reject the null hypothesis H0 while
it is true is 8.82%

Time step / FII

50000
40000
30000
20000
10000

FII

0
-10000

10

20

30

40

50

60

70

80

-20000
-30000
-40000
-50000

Time step

The lag order (l) is determined using Hannan and Quinn Information Criteria
(HQIC), Akaike Information Criterion (AIC) and Schwarz Bayesian Information
Criterion (SBIC) used popularly in the literature.
Summary statistics:
Variable
FII

Obs.

Obs. with missing

Obs. w/o
Minimum Maximum
data
missingdata
72
0
72 -40902.5 40757.29

Std.
deviation
10971.797 15415.26

Mean

Evolution of the BIC for each model:

Model/Number
of classes
E

-1606.431733

-1614.985 -1623.54 -1632.07

According to the BIC criterion, the best mixture model is the E (Equal variance)
with 2 component(s)
The EM algorithm converged in 470 iterations
The optimal number of classes occurs at the min choice. The algorithm should be
run with a minimal number of classes fewer than 2

Proportions:

Class
Proportions

Means by class:

Class
1
2
Mean (FII) 11754.81 -35617.3

Variance by class:

Class
1
2
Variance 197850069 197850069

2
0.983

0.017

Selection criterion for the selected model:

BIC
-1606.43

AIC
1597.32

ICL
1608.977

Log-likelihood
-794.663

NEC
DF
0.978

The NEC criterion is lower than 1, there is a clustering structure in the data

Granger causality test

The last step is to identify the causal relationship in the variables. Variable A is said
to Granger cause variable B, if the lags of A can improve a forecast for variable B.
In a VAR model, the null hypothesis that variable A does not Granger cause
variable B, if all the coefficients on the lags of variable A are zero in the equation
for variable B. The VAR model in the bivariate framework for FDI and is given by
NIFTY=o+ 1NIFTY + 1FII +1

Where l is the optimum lag order, and are the coefficients of Nifty and FII and
e1 and e2 are the white noise error terms. From the equation, the null assumption
is that FII does not granger cause NIFTY if the beta value is zero i.e. if H0: 1 = 0
(NIFTY FII). In equation, the null assumption is that NIFTY does not granger
cause FDI if H0: 2 = 0 (FII NIFTY).
Similarly, we have causal equations for FDI and exports in a bivariate VAR
framework as
=o+ 1 + 1 +1

=o+ 2 + 2 +2

=1

Where EXP is the exports. The null assumption in equation 7 is that EXP does not
granger cause FDI if the beta value is zero (EXP FDI). In equation 8, the null
assumption is that FDI does not granger cause EXP if H0: 2 = 0 (FDI EXP).
Equation for imports in VAR model is given by:
=o+ 1 + 1 +1
=o+ 2 + 2 +2

=1

Where IMP is the imports. Following equation the null assumption is that IMP does
not cause FDI and vice versa for the second equation.
Running a regression analysis, where A is the DV, and lag_A is the IV. This is the
unrestricted regression. The residual sum of squares from this analysis is called
RSS_r. Running another regression analysis, where A is the DV, and lag_A and
lag_B are the IVs - this is the unrestricted analysis. The residual sum of squares
from this analysis is called RSS_ur.
Now, to calculate F: F=((RSS_r-RSS_ur)/m)/(RSS_ur/(n-k))
Where m is the number of lagged terms; n is the number of cases in the analysis
and k is the number of parameters in the unrestricted regression (i.e. 2 in this
case.) This F is distributed with m, n-k df.

Causal Relationship between FII and Nifty

RSS_r
RSS_ur
RSS-r - RSS_ur
F- value
Critical F

55,50,626.02
43,62,223.15
11,88,402.87
19.07013884
3.977779393

Causal Relationship between FII and SENSEX

RSS_r
RSS_ur
RSS-r - RSS_ur
F- value
Critical F

58045054
46433076.18
11611977.81
17.50559114
3.977779393

The results in Table 6 indicate that FII and NIFTY have long run relation for the two
periods, as the F-values are higher than critical values. This implies that there
exists a stable long run relation between FII and SENSEX. Similarly, FDI has a
long-term relationship with exports and imports.

6.DATAANALYSIS
The following table presents the amount of flow of FDI and FII in India in terms of
US$ million and Rs. Crore. The flow of FDIs has shown an increasing trend during
the considered period except during the years i.e. 2001 to 2004 and the year 201011. The flow of FII has shown a mixed trend, during the year 2008-09 there was a
negative flow of FII. When flow of FII and FDI are compared, the flow of FII is less
than flow of FDI in to India except for three years i.e. from 2003 to 2006.

FOREIGN INVESTMENT INFLOWS

A. Direct investment

B. Portfolio investment

Total (A+B)

Rs. Crore

US $ million

Rs. crore

US $ million

Rs. crore

US $ million

1990-91

174

97

11

185

103

1991-92

316

129

10

326

133

1992-93

965

315

748

244

1713

559

1993-94

1838

586

11188

3567

13026

4153

1994-95

4126

1314

12007

3824

16133

5138

1995-96

7172

2144

9192

2748

16364

4892

1996-97

10015

2821

11758

3312

21773

6133

1997-98

13220

3557

6794

1828

20014

5385

1998-99

10358

2462

-257

-61

10101

2401

1999-00

9338

2155

13112

3026

22450

5181

2000-01

18406

4029

12609

2760

31015

6789

2001-02

29235

4095

9639

2021

38874

8151

2002-03

24367

2764

4738

979

29105

6014

2003-04

19860

2229

52279

11377

72139

15699

2004-05

27188

6051

41854

9291

69042

13003

2005-06

39674

9697

55307

12492

94981

16261

2006-07

103367

22826

31713

6947

135080

14640

2007-08

140180

34843

109741

27434

249921

43325

2008-09

161536

41873

-63618

-14032

97918

8311

2009-10

176304

37745

153511

32396

329815

50361

Year

2010-11

34847

30292

41597

2011-12

46553

17171

39177

2012-13

34298

26891

46710

2013-14

36046

4822

26385

2014-15

45148

42205

73457

A. Correlation between FDI & FII and Sensex & Nifty:

Correlation is applied to study the statistical relationship of the variables FDI, FII,
BSE Sensex and CNX Nifty. The following table presents the output, when
correlation is run to the data considered. Based on the results it can be concluded
that there is a positive correlation between FDI & Sensex and FDI & nifty, and the

correlation is found to be significant at 5 percent level of significance. When it

comes to FII it was found that there is a moderate positive correlation between FII
& Sensex and FII & nifty but the correlation is not significant at 5 percent level of
significance.
Correlation Coefficient
Summary statistics:

Variable

Obs. with
missingdata

Observations

FII
FDI INFLOWS
NIFTY

72
72
72

Obs.
without
missing
data
0
72
0
72
0
72

Minimum

Maximum

-40902.5
4725
4624.3

40757.29
126823
8844.6

Std.
deviation

Mean

10971.797 15415.26
14570.847
15391
6306.827 1242.48

Proximity matrix (Pearson correlation coefficient):

FII
FII
FDI INFLOWS
NIFTY

1
-0.003
0.115

FDI INFLOWS
-0.003
1
0.185

NIFTY
0.115
0.185
1

B. Impact of flow of FDIs and FIIs on BSE Sensex

Summary statistics:

Variable
FII
FDI INFLOWS
SENSEX

Observations
72
72
72

Obs. with missingdata

Obs. without
missingdata

0
0
0

Proximity matrix (Pearson correlation coefficient):

Std.
deviation
72 -40902.5 40757.29 10971.8 15415.26
72
4725
126823 14570.85
15391
72 15454.92 29220.12 20966.99 4100.314
Minimum Maximum

Mean

FII
FII
FDI INFLOWS
SENSEX

1
-0.003
0.116

FDI INFLOWS
-0.003
1
0.177

SENSEX
0.116
0.177
1

Multi regression OLS is used to analyze the data.

Independent Variable: FDI and FII Dependent Variable: BSE SENSEX
The table below is the model summary reports the strength of the relationship
between the model and the dependent variable. R, the multiple correlation
coefficients, is the linear correlation between the observed and model- predicted
values of the dependent variable. Its large value indicates a strong relationship. R
Square, the coefficient of determination, is the squared value of the multiple
correlation coefficients. The value of R2 is 0.606; it shows that the model explains
60.06% of the variation. In other words the dependent variables FDI and FII are
able to explain around 60% the variation of the dependent variable (SENSEX).
Durbin-Watson static informs us whether the assumption of independent errors is
tenable. The closer to 2 the value is the better and for the data it was 1.588, which
is close to the 2.
The ANOVA table, tests the acceptability of the model from a statistical
perspective. The Regression row displays information about the variation
accounted for by the model. The Residual row displays information about the
variation that has not been accounted by the model. The regression is much less
than residual sums of squares, which indicates that around 60% of the variation in
SENSEX, is explained by the model. However, F statistic is found significant, since
the p value (0.000) less than 0.05.

Linear Regression
Regression Statistics
R

0.77854

R Square
Adjusted R Square

0.60612
0.6005

S
13,594.76999
Total number of observations
72
SENSEX = 0.4172 * FII +0.5608 * FDI INFLOWS
ANOVA

d.f.

Regression
Residual
Total

SS
MS
F
1.99087E+10 9,95,43,52,419.20918 53.86036
1.29372E+10
18,48,17,770.97889
3.28459E+10

2.
70.
72.
Coefficients

Standard Error

Intercept
FII
FDI INFLOWS

0
0.41721
0.56084
T (5%)
1.99444
LCL - Lower value of a reliable interval (LCL)
UCL - Upper value of a reliable interval (UCL)

0.09283
0.0828

LCL

UCL
0.23205
0.3957

p-level
6.88338E-15

t Stat

0.60236
0.72597

p-level

4.4941
6.77346

0.00003 Yes
0. Yes

Residuals Statistics

Predicted Value
Residual
Std. Predicted Value
Std. Residual

Minimum
-12335.81836
-55622.179688
-2.333
-4.091

Maximum
75126.35938
31731.628906
5.802
2.334

a. Dependent Variable: VAR00004

b. Linear Regression through the Origin
Charts

Mean
12749.35891
8217.631042
.000
.604

Std. Deviation
10750.291089
10664.620232
1.000
.784

H0 (5%) rejected?

N
72
72
72
72

Testing for Collinearity in the data

Table 10 presents the coefficients and Collinearity statistics when multi regression
is applied. The two Collinearity statistics are tolerance and VIF. A value of VIF
higher than 10, and tolerance less than 0.2 indicates a potential problem. For our
current model the VIF values are all well below ten and the tolerance statistic is as
well above 0.2 for all the independent variables. Hence there is no problem of
Collinearity among the variables used in the model and multi regression is
appropriate.

Multicollinearity statistics:

Statistic
R
Tolerance
VIF

FII
FDI INFLOWS SENSEX
0.014
0.032
0.045
0.986
0.968
0.955
1.014
1.033
1.047

Testing the hypothesis:

FDI:The null hypothesis and alternative hypothesis with respect to BSE SENSEX
and FDI can be stated as follows:
H01: Flow of FDIs in to India and SENSEX trend are independent. Ha1: Flow of
FDIs in to India and SENSEX trend are dependent.
The p-value related to FDI shown, is .000 less than 0.05 so null hypothesis H03 is
not accepted. Hence it is concluded that Flow of FDIs in to India and SENSEX
trend are dependent.
FII:The null hypothesis and alternative hypothesis with respect to SENSEX and FII
can be stated as follows:
H02: Flow of FIIs in to India and SENSEX trend are independent.Ha2: Flow of FIIs
in to India and SENSEX trend are dependent.
The p-value related to FDI shown, is .005 less than 0.05 so null hypothesis H04 is
not accepted. Hence it is concluded that Flow of FIIs in to India and SENSEX trend
are dependent.

Independent Variable: FDI and FII Dependent Variable: CNX NIFTY

The table 11 is the model summary reports the strength of the relationship between
the model and the dependent variable. R, the multiple correlation coefficients, is
the linear correlation between the observed and model- predicted values of the
dependent variable. Its large value indicates a strong relationship. R Square, the
coefficient of determination, is the squared value of the multiple correlation
coefficients. The value of R2 is 0.607; it shows that the model explains 60.7% of
the variation. In other words the dependent variables FDI and FII are able to
explain around 60.7% the variation of the dependent variable (NIFTY). DurbinWatson static informs us whether the assumption of independent errors is tenable.
The closer to 2 the value is, the better and for the data it was 1.699 that is very
close to the 2.
The ANOVA table, tests the acceptability of the model from a statistical
perspective. The Regression row displays information about the variation
accounted for by the model. The Residual row displays information about the
variation that has not been accounted by the model. The regression is much less
than residual sums of squares, which indicates that around 94% of the variation in
NIFTY is explained by the model. However, F statistic is found significant, since the
p value (0.000) less than 0.05.

Linear Regression
Regression Statistics
R
R Square
Adjusted R Square

0.77923
0.60721
0.6016

S
4,084.75353
Total number of observations
72
NIFTY = 0.1253 * FII +0.1692 * FDI INFLOWS
ANOVA
d.f.
Regression
Residual
Total

2.

SS
1,80,55,18,786.4652

MS
90,27,59,393.2326

70.
72.

1,16,79,64,795.24158
2,97,34,83,581.70678

1,66,85,211.36059

Coefficients
0
0.12525
0.16918
T (5%)
1.99444
LCL - Lower value of a reliable interval (LCL)
UCL - Upper value of a reliable interval (UCL)

Standard Error

Intercept
FII
FDI INFLOWS

0.02789
0.02488

LCL

F
54.10536

UCL
0.06962
0.11957

p-level
6.21725E-15

t Stat

0.18089
0.2188

p-level

4.49044
6.8005

0.00003 Yes
0. Yes

Residuals Statistics
Predicted Value
Residual
Std. Predicted Value
Std. Residual

Minimum
-3696.63574
-16726.964844
-2.328
-4.095

Maximum
22657.16602
9538.835938
5.813
2.335

a. Dependent Variable: VAR00003

b. Linear Regression through the Origin

Charts

Mean
3839.41695
2467.410131
.000
.604

Std. Deviation
3237.452410
3205.674275
1.000
.785

H0 (5%) rejected?

N
72
72
72
72

Testing for Collinearity in the data

Table 12 presents the coefficients and collinearity statistics when multi regression
is applied. The two Collinearity statistics are tolerance and VIF. A value of VIF
higher than 10, and tolerance less than 0.2 indicates a potential problem. For our
current model the VIF values are all well below ten and the tolerance statistic is as
well above 0.2 for all the independent variables. Hence there is no problem of
Collinearity among the variables used in the model and multi regression is
appropriate.

Multicollinearity statistics:
Statistic
R
Tolerance

FII
0.014
0.986

FDI INFLOWS NIFTY

0.035
0.048
0.965
0.952

VIF

1.014

1.036

1.05

Testing the hypothesis:

FDI:The null hypothesis and alternative hypothesis with respect to CNX NIFTY and
FDI can be stated as follows:
H03: Flow of FDIs in to India and NIFTY trend are independent.Ha3: Flow of FDIs
in to India and NIFTY trend are dependent.
The p-value related to FDI shown, is .000 less than 0.05 so null hypothesis H03 is
not accepted. Hence it is concluded that Flow of FDIs in to India and CNX NIFTY
trend are dependent.
FII:The null hypothesis and alternative hypothesis with respect to CNX NIFTY and
FII can be stated as follows:
H04: Flow of FIIs in to India and CNX NIFTY trend are independent.Ha4: Flow of
FIIs in to India and CNX NIFTY trend are dependent.
The p-value related to FDI shown, is .005 less than 0.05 so null hypothesis H04 is
not accepted. Hence it is concluded that Flow of FIIs in to India and CNX NIFTY
trend are dependent.

In order to understand the magnitude of effect of FDI on exports and imports we

established the imports and exports as function of FDI. The regression equations
of import function and export function are given by:
EXP =1t +1t FDI +1t
IMP =2t +2t FDI +2t
Where EXP is the Exports at time t, IMP is the imports, is the intercept, 1 and
2 are the beta coefficients respectively, 1 and2 are the error terms.
Table 13 and 14 provides the result of export and import function expressed by the
equations. The beta values for FDI are significant at 5% confidence level. Thus FDI
is one of the important determinants of export and import respectively. However,
1% increase in FDI raises imports by 11.8 times as compared to exports which
rises by 7.44 times. As a result, the magnitude of imports due to FDI is more as
against exports. The variance of imports explained by FDI is 73.3% given by
adjusted R-square value in contrast to exports varian ce, which is merely 70% of
the total.

Linear Regression
Regression Statistics
R
R Square
Adjusted R Square
S
Total number of observations

0.85372
0.72884
0.70799
3,370.4186
15

Exports = 809.8247 +7.4479 * FDI

ANOVA
d.f.
Regression
Residual
Total

1.
13.
14.

Coefficients
809.82472
7.4479
T (5%)
2.16037
LCL - Lower value of a reliable interval (LCL)
UCL - Upper value of a reliable interval (UCL)
Intercept
FDI

SS
39,69,41,253.0731
14,76,76,379.92033
54,46,17,632.99343

MS
39,69,41,253.0731
1,13,59,721.53233

F
34.94287

Standard Error
1,587.44234
1.25995

LCL
-2,619.63595
4.72593

UCL
4,239.2854
10.16986

Residual
2,849.8575
4,586.00848
4,922.0913
2,474.01536
988.94142
-3,931.19662
-6,429.27784
-4,513.67467
-2,626.52809
908.93927
1,001.04096
752.40766
-26.09771
-854.51167
-102.01535

Standard Residuals
0.87747
1.41203
1.51551
0.76175
0.30449
-1.21041
-1.97957
-1.38976
-0.80871
0.27986
0.30822
0.23167
-0.00804
-0.2631
-0.03141

p-level
0.00005

t Stat
p-level
H0 (5%) rejected?
0.51014
0.6185 No
5.91125
0.00005 Yes

Residuals
Observation
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15

Predicted Y
16,500.78532
14,724.7273
11,754.80462
12,351.15758
10,667.70984
12,564.01843
15,008.88004
11,193.75467
8,455.23809
3,748.54073
2,816.80904
2,286.74234
2,626.88771
2,987.96167
2,180.53535

Residuals

Residuals [FDI]
10000.00
8000.00
6000.00
4000.00
2000.00
0.00
-2000.00
-4000.00
-6000.00
-8000.00
-10000.00
0.00

500.00

1000.00

1500.00

2000.00

2500.00

3000.00

2000.00

2500.00

3000.00

FDI

Exports

Predicted Y [FDI]
20000.00
18000.00
16000.00
14000.00
12000.00
10000.00
8000.00
6000.00
4000.00
2000.00
0.00
0.00

500.00

1000.00

1500.00
FDI

Linear Regression
Regression Statistics
R
R Square
Adjusted R Square
S
Total number of observations

0.86728
0.75217
0.73311
5,029.13413
15

Imports =671.8883 +11.8092 * FDI

ANOVA
d.f.
Regression
Residual
Total

1.
13.
14.

Coefficients
671.88827
11.8092
T (5%)
2.16037
LCL - Lower value of a reliable interval (LCL)
UCL - Upper value of a reliable interval (UCL)
Intercept
FDI

SS
99,79,29,785.25146
32,87,98,471.09365
1,32,67,28,256.3451

MS
99,79,29,785.25146
2,52,92,190.08413

F
39.45604

Standard Error
2,368.68514
1.88003

LCL
-4,445.34487
7.74765

UCL
5,789.1214
15.87075

Residual
2,613.66242
5,424.17058
9,295.47984
4,974.92721
1,159.0462
-5,076.57174
-9,131.46704
-6,779.66121
-4,165.93694
1,622.67619
1,481.38695
659.35763
-435.21848
-1,442.48843
-199.3632

Standard Residuals
0.53932
1.11926
1.9181
1.02656
0.23917
-1.04754
-1.88426
-1.39897
-0.85963
0.33484
0.30568
0.13606
-0.08981
-0.29765
-0.04114

p-level
0.00003

t Stat
p-level
H0 (5%) rejected?
0.28365
0.78114 No
6.2814
0.00003 Yes

Residuals
Observation
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15

Predicted Y
25,551.08797
22,735.01423
18,025.97815
18,971.54069
16,302.30751
19,309.04759
23,185.5598
17,136.39121
12,794.26694
5,331.44381
3,854.11305
3,013.65237
3,552.97848
4,125.48843
2,845.2532

Residuals

Residuals [FDI]
10000.00
8000.00
6000.00
4000.00
2000.00
0.00
-2000.00
-4000.00
-6000.00
-8000.00
-10000.00
0.00

500.00

1000.00

1500.00

2000.00

2500.00

3000.00

2000.00

2500.00

3000.00

FDI

Predicted Y [FDI]
30000.00

Imports

25000.00
20000.00
15000.00
10000.00
5000.00
0.00
0.00

500.00

1000.00

1500.00
FDI

7.ModelValidation
All regression analysis and graphical presentations in this study were performed by
Addinsofts XLSTAT 2012 Statistical Software.
Multiple Linear Regression Analysis
Descriptive statistics was used to describe the basic features of the data set in the
study. Correlation analysis was used to examine the relations between FDI, FII and
NIFTY, SENSEX. A linear correlation coefficient (Pearsons r) was used to
determine the degree to which variables were related to covariates. The more the
coefficient differed from 1 or -1 (close to zero), the weaker the relation.
Multiple linear regression models are used to study the linear relationship between
a dependent variable and several independent variables by fitting a linear equation
to observed data samples. The generic form of the linear regression model is
Yi
01x1i2x2i ... kxki

, i =1,2,...N
Where y is the dependent variable, x1, x2, xk are the independent or explanatory
variables, and i index the n sample observations, the term is a random error term.
The fitting is performed by minimizing the sum of the squares of the vertical
deviations from each data point to the line that best fits for the observed data. I
have employed a stepwise regression procedure to select the independent
variables that would result in the best possible model, while at the same time
ensuring statistical significance of the results. The t-statistics was used to test
whether a particular variable contributes significantly to the regression model or not

so as to eliminate statistically insignificant variables. The level of significance ()

for the inclusion of a variable in the model was 0.05. For the coefficient bj of the j
variable, H0: bj = 0 and Ha: bj = 0. This t statistic can be formed as
T= bj / Sbj
Where Sbj is the standard deviation of the respective coefficient bj. The F-ratio,
which is computed from the mean squared terms in the Analysis of variance
(ANOVA) table, estimates the statistical significance of the regression equation.
The F-ratio is given by
F= MSR/MSE
where MSR mean square error of regression and MSE mean square error of the
residuals.
7.1 Evaluation of the models
To evaluate the models I have used statistical performance measures, which is
included:
Coefficient of determination (R2), Adjusted R2 (R2), mean square error (MSE), root
mean square error (RMSE), Akaikes Information Criteria (AIC), and Schwarz
Bayesian Criteria (SBC). The definitions of the statistical measures of the
goodness of fit used herein are the following:
R2 =1-SSE/SST
R2 1n
-i) SSE/(n-k) SST
MSE= SSE/n-k

RMSE = SQRT (MSE)

AIC = n*ln(SSE/n) + 2k
SBC=n*ln(SSE/n) + k ln n
Where SSE is the sum of squared errors, SST is total sum of squares, n is number
of observations, k is the number of independent variables, ln is natural logarithm.
7.2 Checking Multiple Linear Regression Assumptions
In order to use the proposed multiple regression analysis, it is necessary to test
and verify that the proposed equation satisfies the assumptions. Assumptions of
multiple linear regression tested in this study to validate the proposed multiple
regression

analysis

nonautoregression

are:

(1)

(randomness

homoscedasticity
of

residuals),

(Constant

nonstochastic

variance),
(errors

are

uncorrelated with the individual predictors), normality of the error distribution, were
examined by plotting of the residuals against predicted values (2) multicollinearity
among predictor variables were tested by Variance Inflation Factor (VIF) described
in
VIFj = R2j
Where R2 is multiple coefficient of determination between xij and all xi

8.CONCLUSION
The flow of FDI & FII accelerated the Indian economy and also gave opportunities
to Indian industry for technological up-gradation, gaining access to global
managerial skills and practices, optimizing utilization of human and natural
resources and global competitive advantage with greater efficiency. Most
importantly FDI is central for Indias integration into global production chains which
involves production by MNCs spread across locations all over the world.From the
current study it is evident that there is a strong positive correlation between FDI &
Sensex and FDI & NIFTY and moderate positive correlation between FII & Sensex
and FII & NIFTY. Using Multi regression two significant models emerged. In the first
model Sensex as a dependent variable, both FDI and FII were found to be
significant predictor. Similar results were obtained for second model Nifty as a
dependent variable. Hence it can be concluded that the impact of flow of FDI & FII
on Indian stock market is significant.

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