Definition of 'Foreign Institutional Investor - FII' An investor or investment fund that is from or registered in a country outside of the one

in which it is currently investing. Institutional investors include hedge funds, insurance companies, pension funds and mutual funds. Investopedia explains 'Foreign Institutional Investor - FII' 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 the Securities and Exchange Board of India to participate in the market. One of the major market regulations pertaining to FIIs involves placing limits on FII ownership in Indian companies. The term foreign institutional investment denotes all those investors or investment companies that are not located within the territory of the country in which they are investing. These are actually the outsiders in the financial markets of the particular company. Foreign institutional investment is a common term in the financial sector of India. The type of institutions that are involved in the foreign institutional investment are as follows:

Mutual Funds Hedge Funds Pension Funds Insurance Companies

The economies like India, which are growing very rapidly, are becoming hot favorite investment destinations for the foreign institutional investors. These markets have the potential to grow in the near future . This is the prime reason behind the growing interests of the foreign investors. The promise of rapid growth of the investable fund is tempting the investors and so they are coming in huge numbers to these countries. The money, which is coming through the foreign institutional investment is referred as 'hot money' because the money can be taken out from the market at anytime by these investors.

The foreign investment market was not so developed in the past. But once the globalization took the whole world in its grip, the diversified global market became united. Because of this the investment sector became very strong and at the same time allowed the foreigners to enter the national financial market. At the same time the developing countries understood the value of foreign investment and allowed the foreign direct investment and foreign institutional investment in their financial markets. Although the foreign direct investments are long term investments but the foreign institutional investments are unpredictable. The Securities and Exchange Board of India looks after the foriegn institutional investments in India. SEBI has imposed several rules and regulations on these investments. Some important facts about the foreign institutional investment:

The number of registered foreign institutional investors on June 2007 has reached 1042 from 813 in 2006 US $6 billion has been invested in equities by these investors The total amount of these investments in the Indian financial market till June 2007 has been estimated at US $53.06 billion The foreign institutional investors are preferring the construction sector, banking sector and the IT companies for the investments Most active foreign institutional investors in India are HSBC, Merrill Lynch, Citigroup, CLSA Foreign Institutional Investment Changes to the SEBI (Foreign Institutional Investors) Regulations, 1995 In 1996-97, several changes have been made to the SEBI (Foreign Institutional Investors) Regulations, 1995 to diversify the foreign institutional investor base and to further facilitate inflow of foreign portfolio investment. The changes have also aimed at facilitating investment in debt securities through the FII route. The changes are as follows:

the eligible categories of FIIs have been expanded to include university funds, endowments, foundations, charitable trusts and charitable societies which have a track record of 5 years and which are registered with a statutory authority in their country of incorporation or establishment

each FII or sub-account of an FII has been permitted to invest upto 10% of the equity of any one company, subject to the overall limit of 24% on investments by all FIIs, NRIs and OCBs the 24% limit may be raised to 30% in the case of individual companies who have obtained shareholder approval for the same FIIs have been permitted to invest in unlisted securities FIIs have been allowed to invest their proprietary funds FIIs who obtain specific approval from SEBI have been permitted to invest 100% of their portfolios in debt securities. Such investment may be in listed or to be listed corporate debt securities or in dated government securities, and is treated to be part of the overall limit on external commercial borrowing.

The impact of these changes was felt as several endowment funds, proprietary funds and 100% debt funds of FIIs obtained registration. Further details are given in Part II of this Report. In order to simplify the FII registration process, SEBI and RBI set up a co-ordination committee. At the end of 1996-97 there were no applications for FII registration pending with SEBI and RBI. Foreign investment in Indian securities has also been made possible through the purchase of Global Depository Receipts, Foreign Currency Convertible Bonds and Foreign Currency Bonds issued by Indian issuers which are listed, traded and settled overseas. Foreign investors, whether registered as FII or not, may also invest in Indian securities outside the FII route. Such investment requires case by case approval from the Foreign Investment Promotion Board (FIPB) and the RBI, or only by the RBI depending the size of investment and the industry in which this investment is to be made. Foreign financial services institutions have also been allowed to set up joint ventures in stock broking, asset management companies, merchant banking and other financial services firms along with Indian partners. The foreign participation in financial services requires the approval of FIPB. In 1996-97, the FIPB announced guidelines for foreign investment in the non-banking financial services sector.

Highlights of New Rules

New norms to come into effect from tomorrow Unregulated pension fund, university fund, charitable fund, endowments etc to be treated as FIIs No dilution of know-your-customers norms for registration of FIIs to prevent money laundering FIIs to be registered on a permanent basis instead of earlier practice of renewing registration every three years

Foreign Institutional Investor (FII) Foreign Institutional Investors (FII) include the following foreign based categories:

Pension Funds Mutual Funds Investment Trust Insurance or reinsurance companies Investment Trusts Banks Endowments University Funds Foundations Charitable Trusts or Charitable Societies

Further, following entities proposing to invest on behalf of broad based funds, are also eligible to be registered as FIIs:

Asset Management Companies Institutional Portfolio Managers Trustees Power of Attorney Holders

Q1. Who is a Foreign Institutional Investor (FII)? Ans. FII means an entity established or incorporated outside India which proposes to make investment in India. Q2. What is a sub-account?

Ans. Sub-account includes those foreign corporations, foreign individuals, and institutions, funds or portfolios established or incorporated outside India on whose behalf investments are proposed to be made in India by a FII. Q3. What is a Designated Bank? Ans. Designated Bank means any bank in India which has been authorized by the Reserve Bank of India to act as a banker to FII. Q4. Who is a Domestic Custodian? Ans. Domestic Custodian means any entity registered with SEBI to carry on the activity of providing custodial services in respect of securities. Q5. What is a Broad Based Fund? Ans. Broad Based Fund means a fund established or incorporated outside India, which has at least twenty investors with no single individual investor holding more than 10% shares or units of the fund. Provided that if the fund has institutional investor(s) it shall not be necessary for the fund to have twenty investors. Provided further that if the fund has an institutional investor holding more than 10% of shares or units in the fund, then the institutional investor must itself be broad based fund.

FII REGISTRATION

Q6. Who can get registered as FII? Ans. Following entities / funds are eligible to get registered as FII: 1. 2. 3. 4. 5. Pension Funds Mutual Funds Insurance Companies Investment Trusts Banks

6. 7. 8. 9.

University Funds Endowments Foundations Charitable Trusts / Charitable Societies

Further, following entities proposing to invest on behalf of broad based funds, are also eligible to be registered as FIIs: 1. 2. 3. 4. Asset Management Companies Institutional Portfolio Managers Trustees Power of Attorney Holders

Q7. What are the parameters on which SEBI decides FII applicants eligibility? Ans. a. Applicants track record, professional competence, financial soundness, experience, general reputation of fairness and integrity. (The applicant should have been in existence for at least one year) b. whether the applicant is registered with and regulated by an appropriate Foreign Regulatory Authority in the same capacity in which the application is filed with SEBI c. Whether the applicant is a fit & proper person. Q8. Which form needs to be filled in when applying for FII registration? Ans. "Form A" as prescribed in SEBI (FII) Regulations, 1995. Q9. Which documents need to be sent with "Form A"? Ans. a. Certified copy of relevant clauses (clauses permitting the stated activities) of Memorandum of Association, Article of Association or Article of Incorporation. b. Audited financial statement and annual report for the last one year (period covered should not be less than twelve months Q10. How much is the fee for registration as FII?

Ans. US $ 5,000. Q11. When is the registration fee payable? Ans. At the time of submitting the application for registration. Q12. What is the mode of payment? Ans. Demand Draft in favour of "Securities and Exchange Board of India" payable at New York Q13. How many days it takes to get registered as FII? Ans. SEBI generally takes seven working days in granting FII registration. However, in cases where the information furnished by the applicants is incomplete, seven days shall be counted from the days when all necessary information sought, reaches SEBI. In cases where the applicant is bank and subsidiary of a bank, SEBI seeks comments from the Reserve Bank of India (RBI). In such cases, 7 working days would be counted from the day no objection is received from RBI. Q14. What is the registration process for FII? Ans. Please contact us for registration.

Q15. What is the validity period of FII registration? Ans. The FII registration is valid for 5 years. After expiry of 5 years, the registration needs to be renewed. Q16. What is the process of renewal? Ans. Same as initial registration. Along with "Form A" and all the relevant documents, the applicants are required to fill in additional form (Annexure 1) while applying for renewal. Q17. Is there any renewal fee? Ans. Yes, US $ 5,000 needs to be paid for renewal of FII registration.

Q18. When the application for renewal should be submitted Ans. Three months before expiry of the FII registration. Q19. What are 100 % debt FIIs/sub-accounts, and what is the process for their registration? Ans. 100 % debt FIIs are debt dedicated FIIs which invest in debt securities only. The procedure for registration of FII/sub-account, under 100% debt route is similar to that of normal funds besides a clear statement by the applicant that it wishes to be registered as FII/sub-account under 100% debt route. Q20. Where the application for FII registration should be sent? Ans. The FII registration application should be sent to: Securities Division Mittal 224, Mumbai India and of Court Exchange Board FII & "B" Wing, Nariman 400 of First India Custodian Floor Point 021

Note: In case the applicant is a Bank or "Subsidiary of a Bank" then the application form and relevant documents need to be submitted in duplicates.

SUB-ACCOUNT REGISTRATION

Q21. Who can get registered as sub-account? Ans. a. Institution or funds or portfolios established outside India, whether incorporated or not. b. Proprietary fund of FII. c. Foreign Corporates d. Foreign Individuals

Q22. Who need to apply for sub-account registration? Ans. The FII should apply on the behalf of the Sub-account. Both the FII and the Sub-account are required to sign the Sub-account application form. Q23. Which form needs to be filled when applying for sub-account registration? Ans. "Annexure B" to "Form A" (FII application form). Q24. What documents need to be sent with Annexure A? Ans. None Q25. How much is the fee for sub-account registration? Ans. US $ 1,000 Q26. When is the registration fee payable? Ans. At the time of submitting the application. Q27. What is the mode of payment? Ans. Demand Draft in the name of "Securities and Exchange Board of India" payable at New York Q28. How many days it takes to get a sub-account registered? Ans. SEBI generally takes three working days in granting FII registration. However, in cases where the information furnished by the applicants is incomplete, three days shall be counted from the days when all necessary information sought, reaches SEBI. Q29. What is the validity period of sub-account registration? Ans. The validity of sub-account registration is co-terminus with the FII registration under which it is registered. Q30. What is the process of renewal of sub-account? Ans. Same as initial registration.

Q31. Is there renewal fee? Ans. Yes, US $ 1,000 Q32. Can OCBs / NRIs permitted to get registered as FII/sub-account? Ans. No, they are not permitted. POST-REGISTRATION PROCESSES Q33. What is the procedure in case the FII/sub-account changes its name? Ans. If a registered FII/sub-account undergoes name change, then the FII need to promptly inform SEBI about the change. It should also mention the reasons for the name change and give an undertaking that there has been no change in beneficiary ownership. In case of name change of FII, the request should be accompanied with documents from home regulator and registrar of the company evidencing approval of name change, and the original FII registration certificate issued by SEBI should be sent back for necessary amendment. Q34. What is the procedure for transferring a sub-account from one FII to another? Ans. The FII to whom the Sub-account is proposed to be transferred has to send a request along with a declaration that it is authorized to invest on behalf of the Subaccount. The transferor FII should also submit a No-objection certificate. Q35. What is the procedure for change of domestic custodian? Ans. The FII should send a request, along with no-objection certificate from existing domestic custodian, for change in domestic custodian. Q36. Can FII/sub-account registration be cancelled on request? Ans. Yes, the FII would be required to send a request for cancellation of its registration or registration of its Sub-account/s clearly mentioning the name and registration number of the entity. The FII should ensure that it / Sub-account has nil cash / securities holdings.

Foreign Institutional Investments (FIIs) in India and the Related Laws In present era of globalization no country or economy has been left untouched from international trade and commerce. More access to international capital markets and foreign investments has helped developing countries surmount their less developed capital markets. During the past few years, a flow of capital has been seen from the developed part of the world to the less developed economies which has led to decrease in the vulnerability of developing countries to financial crisis by reduction in their external debt burden from 39% of gross national income in 1995 to 26% in 2006 and increase in foreign exchange reserves to 92% of long term debt and 423% of more volatile short term debt in 200 Over the years same scenario has been witnessed in the Indian economy also. And thus, today most of the market entities are interested in attracting foreign capital as it not only helps in creating liquidity for the firms stock and the stock market but also leads to lowering of the cost of the capital for the firms and allows them to compete more effectively in the global market place. Foreign Investment It has been defined as a transfer of funds or materials from one country (called capital exporting country) to another country (called host country) in return for a direct or indirect participation in the earnings of that enterprise. Foreign investments provide a channel through which one can have access to foreign capital and after the opening up of the Indian economy; these have grown in leaps and bounds. Basically foreign investment can be made through following routes: Foreign Direct Investment (FDI) Foreign Portfolio Investment (FPI). Private Equity investments-Foreign venture capital investor(FVCI) Firstly, foreign direct investment pertains to international investment in which the investor obtains a lasting interest in an enterprise in another country. Mostly it takes the form of buying or constructing a factory in a foreign country or adding improvements to such a facility in form of property, plants or equipments and thus

is generally long term in nature. On the other hand, a private equity investment is one made by foreign investors in Indian Venture Capital Undertakings (VCU) and Venture Capital Funds (VCF). Thirdly, a foreign portfolio investment is a shortterm to medium- term investment mostly in the financial markets and is commonly made through foreign Institutional Investors (FIIs), non resident Indian (NRI) and persons of Indian origin (PIO). BACKGROUND In the late 1980s India suffered an acute financial crunch. At that time Indian foreign exchange stood at mere US $1.2 bn which could barely finance 3 weeks worth of imports. And India had to pledge its gold reserve with IMF to secure a loan of just US $457 mn. The gross fiscal deficit of the government rose from 9.0% of GDP in 1980-81 to 10.4 percent in 1985-86 and to 12.7% in 1990-91. Since these deficits had to be met by borrowings, the internal debt of the government accumulated rapidly, rising from 35% of GDP at the end of 1980-81 to 53% of GDP at the end of 1990-91. According to India Report, Astaire Research A Balance of Payments crisis in 1991 pushed the country to near bankruptcy. In return for an IMF bailout, gold was transferred to London as collateral, the rupee devalued and economic reforms were forced upon India. That low point was the catalyst required to transform the economy through badly needed reforms to unshackle the economy. Controls started to be dismantled, tariffs, duties and taxes progressively lowered, state monopolies broken, the economy was opened to trade and investment,private sector enterprise and competition were encouraged and globalization was slowly embraced. The reforms process continues today and is accepted by all political parties, but the speed is often held hostage by coalition politics and vested interests. Thus it was decided to open up the economy, the economic policies were liberalized and private sector was given the freedom to participate in the Indian economy more effectively. The Indian market was integrated with the world economy and international investors were invited to participate in India. Consequently, the committee on the reforms of the financial system under the chairmanship of Mr M. Narsimham Rao was made which sought for reforms in the financial sector. One of its recommendation included developing an active

government securities market and strengthening the open market operations as an instrument of monetary policy.And thus this reform paved way for foreign investments which were at that time the need of the hour. As a result of this, Indian stock market witnessed metamorphic changes and a transition-from a dull to a highly buoyant stock market. Improved market surveillance system, trading mechanism and introduction of new financial instruments made it a center of attraction for the international investors.

FOREIGN INSTITUTIONAL INVESTORS The term FII is used to denote an investor, mostly in the form of an institution or entity which invests money in the financial markets of a country different from the one where in the institution or the entity is originally incorporated. According to Securities and Exchange Board of India (SEBI) it is an institution that is a legal entity established or incorporated outside India proposing to make investments in India only in securities These can invest their own funds or invest funds on behalf of their overseas clients registered with SEBI. The client accounts are known as sub-accounts. A domestic portfolio manager can also register as FII to manage the funds of the sub-accounts. From the early 1990s, India has developed a framework through which foreign investors participate in the Indian capital market. A foreign investor can either come into India as a FII or as a sub-account. In December 2005, the number of FII and sub-accounts stood at 823 and 2273 respectively. Basically FIIs have a huge financial strength and invest for the purpose of income and capital appreciation. They are no interested in taking control of a company. Some of the big American mutual funds are fidelity, vanguard, Merrill lynch, capital research etc. They are permitted to trade in securities in primary as well as secondary markets and can trade also in dated government securities, listed equity shares, listed non convertible debentures/bonds issued by Indian company and schemes of mutual funds but the sale should be only through recognized stock exchange. These also include domestic asset management companies or domestic portfolio managers who manage funds raised or collected or bought from outside India for the purpose of making investment in India on behalf of foreign corporate

or foreign individuals. In the Indian context, foreign institutional investors (FIIs) and their sub-accounts mostly use these instruments for facilitating the participation of their overseas clients, who are not interested in participating directly in the Indian stock market.

Why are FIIs required? FIIs contribute to the foreign exchange inflow as the funds from multilateral finance institutions and FDI are insufficient. 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 A FII may invest through 2 routes:

Equity Investment 100% investments could be in equity related instruments or upto 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. LIBERALIZATION OF LAWS: Before 1992, only Non-Resident Indians (NRIs) and Overseas Corporate Bodies were allowed to undertake portfolio investments in India. Thereafter, the Indian stock markets were opened up for direct participation by FIIs. They were allowed to invest in all the securities traded on the primary and the secondary market including the equity and other securities/instruments of companies listed/to be listed on stock exchanges in India. Initially, only pension funds, mutual funds, investments trusts, asset management companies, nominee companies and incorporated/institutional portfolio managers were permitted to invest directly in the Indian stock markets. In 1996-97, the group was expanded to include banks, university funds, endowments foundations, charitable trusts, charitable societies, a trustee or power of attorney holder incorporated or established outside India proposing to make proprietary investments or investments on behalf of a broad-based funds. When India opened investment into listed equities through the FII framework not all foreign investors were eligible to register with the Indian securities regulator (SEBI). No FII was permitted to own more than 5% of a firm and there were restrictions on ownership by all FIIs taken together. Foreign investors faced many difficulties in accomplishing transactions in the Indian equity market. For example in 1993, the settlement system which was based on physical paper share certificates found it difficult to handle the settlement volume of foreign investors. Similarly, foreign investors who sent orders to open outcry trading floor of the Bombay stock exchange found an array of problems including high transactions costs and low probability of order execution. Thus from 1993 to 2003, the Ministry of Finance and SEBI led a strong reforms aiming at a fundamental transformation of the equity market. Presently the ceiling for overall investment for FIIs is 24% of the paid up capital of the Indian company. The limit is 20% of the paid up capital

in the case of public sector banks, including the State Bank of India. The ceiling can be raised upto sectoral cap/statutory ceiling, subject to the approval of the board and the general body of the company passing a special resolution to that effect. 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

FII Regulations: Investment by FIIs is regulated under SEBI (FII) Regulations, 1995. Following are some of important regulations by SEBI and RBI: 1. A Foreign Institutional Investor may invest only in the instruments mentioned earlier. 2. The total investments in equity and equity related instruments (including fully convertible debentures, convertible portion of partially convertible debentures and tradable warrants) made by a FII in India, whether on his own account or on account of his sub- accounts, should be at least 70% of the aggregate of all the investments of the FII in India, made on his own account and through his subaccounts. 3. The cumulative debt investment limit for FII investments in Corporate Debt is US $15 billion. The amount was increased from US $6 billion to USD 15 billion in March 2009. 4. US $8 billion will be allocated to the FIIs and Sub-Accounts through an open bidding platform while the remaining amount is allocated on a first come first served basis subject to a ceiling of Rs.249 cr. per registered entity. 5. The debt investment limit for FIIs in government debt is currently capped at $5 billion and cumulative investments under 2% of the outstanding stock and no single entity can be allocated more than Rs. 1000 crores of the government debt limits.

Further, in 2008 amendments were made to attract more foreign investors to register with SEBI, these amendments are: 1. The definition of broad based fund under the regulations was substantially widened allowing several more sub accounts and FIIs to register with SEBI.

2. Several new categories of registration viz. sovereign wealth funds, foreign individual, foreign corporate etc. were introduced, 3. 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, 4. Also the application fee for foreign investors applying for registration has recently been reduced by 50% for FIIs and sub accounts 5. 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. 6. Also the rigid criteria of requiring FIIs and sub-account to register as a 70:30 FII/ sub-account or 100% debt FII/sub-account has recently been done away with(as has been discussed above in the essay). EFFECTS ON INDIAN ECONOMY The various reforms introduced by Indian government to encourage FIIs to invest in Indian market have been effective to such an extent that in November 2010 FIIs stood at 5426 whereas it stood at 1713 in early 1990s. The changes have led to increase in liquidity, reduce risk, improve disclosure and thus FIIs have become the corner stone in the phenomenal rise of the Indian stock market. It has led to shift of focus of foreign investors away from Indian securities traded at London or New York, and the primary markets for India- related equities trading has become the NSE and BSE in Bombay. From the table below it becomes apparent that from just Rs 4 crores of net investment in 1992-93, the investment rose to Rs 5445 the next financial year when the economic changes were introduced and further today in 2010-11 it stands at Rs 133,049. YEAR 1992-93 1993-94 1994-95 Net Investments by FIIs (rs cr.) 4 5445 4777

1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-2010 2010-2011

6721 7386 5908 -729 9765 9682 8273 2669 44000 41416 47,602 36,396.60 71,952 -53,796 84,269 133,049

In 1993 the first and only FII to invest in India was Pictet Umbrella Trust Emerging Markets Fund, an institutional investor from Switzerland but today Indian growth story has attracted global majors like CLSA, HSBC, Citigroup, Merrill Lynch, Crown Capital, Fidelity, Goldman Sachs and Morgan Stanley, among others to enter the Indian financial market. Goldman Sachs and Macquarie have acquired a 20% stake each in PTC India Financial services Ltd. Temasek Holdings, Investment Corporation of Dubai, Goldman Sachs, Macquarie, AIF Capital, Citigroup and India Equity Partners (IEP) have picked a combined

stake of 10% in Bharti Infratel. Also an entity of Merrill Lynch has picked up 49% stake in seven residential projects of real estate major, DLF. This boost, though good for Indian economy has led to a number of negative consequences. Let us study the positive and the negative side of this rise of investments by FIIs one by one. Positive impact: It has been emphasized upon the fact that the capital market reforms like improved market transparency, automation, dematerialization and regulations on reporting and disclosure standards were initiated because of the presence of the FIIs. But FII flows can be considered both as the cause and the effect of the capital market reforms. The market reforms were initiated because of the presence of them and this in turn has led to increased flows. A. Enhanced flows of equity capital: FIIs are well known for a greater appetite for equity than debt in their asset structure. For example, pension funds in the United Kingdom and United States had 68 per cent and 64 per cent, respectively, of their portfolios in equity in 1998. Not only it can help in supplementing the domestic savings for the purpose of development projects like building economic and social infrastructure but can also help in growth of rate of investment, it boosts the production, employment and income of the host country. B. Managing uncertainty and controlling risks: FIIs promote financial innovation and development of hedging instruments. These because of their interest in hedging risks, are known to have contributed to the development of zero-coupon bonds and index futures. 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. E. Issue related to participatory notes: When Indian-based brokerages buy India-based securities and then issue participatory notes to foreign investors. Any dividends or capital gains collected from the underlying securities go back to the investors. Any entity investing in participatory notes is not required to register with SEBI (Securities and Exchange Board of India), whereas all FIIs have to compulsorily get registered. Trading through participatory notes is easy because participatory notes are like contract notes transferable by endorsement and delivery. Secondly, some of the entities route their investment through participatory notes to take advantage of the tax laws of certain preferred countries. Thirdly, participatory notes are popular because they provide a high degree of anonymity, which enables large hedge funds to carry out their operations without disclosing their identity. The hedge funds borrow money cheaply from western markets and invest these funds into stocks in emerging economies. It is also feared that the hedge funds, acting through participatory notes, will cause economic volatility in Indian exchange and generally these are blamed for the sudden fall in indices. These unlike FIIs are not directly registered under SEBI, but they operate through sub accounts with FIIs and according to a number of studies it has been found that more than 50% of the funds are flowing through this anonymous route, which can lead to a great loss to the Indian economy. Further, FIIs have contributed a lot in making Indian economy one of the fastest growing economy in the world today. Foreign institutional investment can play a useful role in development by adding to the savings of low and middle income developing countries. And India among the world inventors is believed to be a good investment destination inspite of all the political uncertainty and

infrastructural inefficiencies. After the liberalization of financial policies India has been able to attract a lot of FII from rest of the world and which in turn has played its part very well by helping in development of Indian economy from what it was in early 1990s to a would be super power that it is today. But still the harsh consequences of FIIs should not be ignored by the government and further reforms should be introduced in the economic sector to counter the tendency of the FIIs to destabilize the emerging equity market. And also attempts should be made to encourage small domestic investors to participate in the equity market.

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