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IMPACT OF INTERNATIONAL FINANCIAL FLOWS ON INDIAN STOCK MARKETS AN EMPIRICAL STUDY Mr. K.S.

.Venkateswara Kumar Assistant Professor, KLU Business School, K L University, Guntur (Dist.), Andhra Pradesh venki@kluniversity.in, 9440618925 Prof. V.Rama Devi KLU Business School, K L University, Guntur (Dist.), Andhra Pradesh ABSTRACT: FDI and FII have become instruments of international economic integration and stimulation. Fast growing economies like Singapore, China, Korea etc have registered incredible growth at onset of FDI. Though US captures 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 countries with cutting edge technology, desired skill sets, tools of innovation and other complementary skills. 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. External factors such as global economic cues, FDI & FII, Exchange rate and Internal factors such as demand and supply, market cap, EPS generally drive and dictates the Indian stock market. The current paper makes an attempt to study the relationship and impact of FDI & FII on Indian stock market using statistical measures correlation coefficient and multi regression for 12 years data starting from 2001 to 2012. Sensex and Nifty were considered as the representative of stock market as they are the most popular Indian stock market indices.

Keywords: FDI, FII, Sensex, Nifty. Introduction: Foreign capital has significant role for every national economy, regardless of its level of development. For the developed countries it is necessary to support sustainable development. For the developing countries, it is used to increase accumulation and rate of investments to create conditions for more intensive economic growth. For the transition countries, it is useful to carry out the reforms and cross to open economy (Edwards, 2004), to cross the past long term problems and to create conditions for stable and continuous growth of GDP (Razin, 2001), as well as integration in world economy (Boskovska, 2006; Lensik, 1999). But, to realize the potential exist in the developing countries, foreign capital plays a very crucial role. 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 captures 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

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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. India is a developing country, like many other developing countries, international capital flows has significant potential benefit on the Indian economy. Under the liberalized foreign exchange transactions regime, the results were dramatic. The liberalization of the portfolio investment led to a surge in inflow of capital for investment (Mody and Murshid, 2002) in the primary and secondary market (Dash and Sumanjeet, 2005) for Indian equity and corporate (and subsequently sovereign) bond market. 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. Need for FDI and FII: In order to develop the basic infrastructure viz., roads, bridges, water supply, sewers, grids, telecommunications, and so forth huge foreign capital in the form of FDI & FII is needed. 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. 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. Influence of Foreign capital on Indian stock market: The foreign capital is freely available and unpredictable too therefore they (FIIs) are always on the lookout for profits. Foreign capital frequently moves investments, and those swings can be expected to bring severe price fluctuations resulting in increased volatility. Foreign capital increased depth and breadth of the market. It plays a major role in expanding securities business. Foreign investors policy on focusing on fundamentals of the shares had caused efficient pricing of shares. These impacts made the Indian stock market more attractive to FIIs and also domestic investors, which involve the other major player MF (Mutual Funds). The impact of FIIs is so high that whenever FIIs tend to withdraw the money from market, the domestic investors become fearful and they also withdraw from market. Literature Review International capital flow such as FDI and FII has huge contribution to influence the stock markets. Rao et al.(1999) in their study of foreign institutional investments and Indian stock market found that the net FII investments influence the stock prices in India.

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In the similar line Chakrabarti (2001) concluded in his study that in the pre-Asian crisis period any change in FII was found to have a positive impact on the equity returns, whereas in the postAsian crisis the reverse relationship was noticed. FIIs accounting for a major portion of investments, their roles in determining share price movements and the movement of various indices is considerably high. The movement of indices in Indian markets depends on the trade done in limited number of stocks only. Thus, when FIIs frequently buy and sell stocks in the indices it leads to volatility of the market (Vijay, 2006). To examine the volume of foreign investment and profit booking in Indian market, Trivedi and Nair (2006) in their study suggested that, given the huge volume of investments, foreign investors can play the role of market makers and book their profits. They can buy financial assets when the prices are declining and sell when the asset prices are increasing. Hence there is a possibility of a bi-directional relationship between FII and equity returns. Study conducted by Kumar (2002) on the role of institutional investors (including the FIIs) in Indian stock market found that FIIs and Indian mutual funds combined together are the most powerful force in driving the Indian market. They used the Granger causality test and found that the mutual funds in fact led the rise or fall in market and FIIs followed suit. Prof. Krugman (1993) rightly pointed out; capital inflows play a very important role in capturing the benefits of globalization. Various studies (Buiter and Patel, 2006; Caballero, 2000) revealed that it is not so much the quantity but the quality of money that is making the difference. Now researchers are conscious about the technological and managerial skills, the work culture, and the synergies accompanying capital flows that seem to give a lot more contribution to growth. Even with regard to portfolio flow from FIIs, the way in which FIIs assess market practices in stock exchanges have enhanced our own practice and skill among participants to global standards (Mohan, 2008). So, one has to look at the capital flows in a broader sense rather than as mere numbers and in any case the issue has to be evaluated in the country context. Looking at the composition of capital flows, net foreign direct investment represents the largest share of private capital flows in the emerging markets. Net portfolio investment is also an important source of finance in the emerging markets, though these flows were more volatile after 1994 (Rangarajan, 2000). A study conducted by the World Bank in 1997 reports that stock market liquidity improved in those emerging economies that received higher foreign investments. Bose and Coondoo (2004) have found mild evidence of bi-directional causality between returns on the BSE stock index and FII net inflows and reasoned that it may have been due to heightened FII inflows caused by an upsurge in global equity markets. The research studies of Banerjee and Sarkar (2006); Badhani (2005); Biswas, Joydeep (2005); and Ananthanarayanan, et. al., (2003) found clear evidence of benefits of foreign capital flows in the form of equity market development, capital market integration, lower cost of capital and increased return etc. In contrast, Rakshit, Mihir (2006), Moel (2000) etc. points towards its adverse impact on the share market return. Prasanna (2008) has examined that foreign investors invested more in companies with a higher volume of shares owned by the general public. The promoters holdings and the foreign investments are inversely related. The financial performance variables which influenced the financial decisions of FII include share returns and earnings per share. Bansal and Pasricha (2009) studied the after impact of opening market to FIIs on Indian stock market behavior. They found that there is no significant change in the Indian stock market

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average returns. The volatility got significantly reduced after India unlocked its stock market to foreign investors. Jayachandran and Seilan (2010) investigated 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. Chopra (2002) 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. John Andreas (2004) 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. Objectives of the Study 1. To study the trends and patterns of foreign capital flow in to India in the form of FDI & FII. 2. To study the impact of Foreign Direct Investment (FDI) on Indian stock market (Sensex and Nifty). 3. To study the impact of Foreign Institutional Investment (FII) on Indian stock market (Sensex and Nifty). Scope of the Study The present study takes 12 years data into consideration. To study the impact of FDI & FII on Indian stock market, Sensex and Nifty was a natural choice to be considered in the study, as it is the most popular stock market indices and widely used by market participants for benchmarking. Research Methodology A. Data Collection This study is based on secondary data. The required data related to FDI and FII have been collected from various sources i.e. Bulletins of Reserve Bank of India, DIPP, publications from Ministry of Commerce, Govt. of India. The BSE Sensex and CNX Nifty data is down loaded from the websites of BSE India and NSE India respectively. Daily closing index value are taken and averaged to get the index value for each year, which is considered as more representative figure of index for the entire year rather any one days/months closing figure of the index . The present study considers 12 years data starting from 2000-01 to 2011-12. B. Analytical Tools & Technique In order to analyze the collected data the statistical tools such as correlation and Multi regression OLS model is used. Correlation coefficient is a statistical measure that determines the degree to

which two variable's movements are associated. Correlation coefficient value ranges from -1 to 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 study the linear relationship between variables such as FDI & FII and Sensex & Nifty correlation is applied. The multiple regression analysis is a statistical technique used to evaluate the effects of two or more independent variables on a single dependent variable. In the current paper attempt is made to study the impact of FDI & FII on Sensex and Nifty. So FDI & FII are considered as the two independent variables the dependent variable for model 1 is Sensex and Nifty for model 2. C. Model Building: Further, to study the impact of Foreign Direct Investment & Foreign Intuitional Investors on Indian stock market, two models were framed and fitted. Model 1 depicts Sensex as dependent variable; where as independent variables are FDI and FII. Model 2 depicts Nifty as dependent variable; where as independent variables are FDI and FII.

The two model equations are expressed below: BSE SENSEX=0+1(FDI)+2(FII) CNX NIFTY= 0+1(FDI)+2(FII)

Data Analysis The following table 1 represents the flow of FDI, FII (both in terms of US$ million) in India and BSE SENSEX and CNX NIFTY for a period of twelve years (2000-01 to 2011-12). The flow of FDIs has been shown an increasing trend during the considered period except during the year i.e. 2001 to 2004 and the year 2010-11.The flow of FII has shown a mixed trend 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. 2003 to 2006. The flow of BSE SENSEX shown increasing trend during the considered period except during the period 2001-03 and 2008-09. The flow of CNX NIFTY has shown increasing trend except the years 2001-02 and 2008-09.

Table 1: Flow of FDI and FII


Year 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 FDI (US $ million) 4,029 6,130 5,035 4,322 6,051 8,961 22,826 34,835 41,874 37,745 32,901 36504 FII (US $ million) 1,847 1,505 377 10,918 8,686 9,926 3,225 20,328 -15,017 29,048 29,422 17365 BSE Sensex 4269.68 3331.94 3206.28 4493.53 5740.98 8280.08 12277.32 16568.88 12365.55 15585.21 18605.17 17,404.20 CNX Nifty 1334.76 1077.02 1037.22 1427.5 1805.26 2513.44 3572.44 4896.59 3731.02 4657.76 5583.54 5295.55

Source: FDI & FII from various reports of DIPP & RBI BSE & NSE from BSE India and NSE India websites

Time Series Plot of FDI (US $ mi, FII (US $ mi, BSE Sensex, CNX Nifty
40000 30000
Variable FDI (US $ million) FII (US $ million) BSE Sensex C NX Nifty

Data

20000 10000 0 -10000 -20000

01 02 03 04 05 06 07 08 09 10 11 12 0- 01- 02- 03- 04- 05- 06- 07- 08- 09- 10- 110 20 20 20 20 20 20 20 20 20 20 20 20
Year

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 2 presents the output, when correlation is run to the 12 years data considered. Based on the results it can be concluded that there is a very strong positive correlation between FDI & Sensex and FDI & nifty, and the correlation is found to be significant at 1 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 1 percent level of significance.
Table 2:Correlations FDI million) Pearson Correlation 1 FDI million) (US $ Sig. (2-tailed) N 12 (US $ FII (US $ BSE Sensex .917** .000 12 .586* .045 12
**

CNX Nifty .917** .000 12 .590* .043 12 1.000** .000

million) .315 .319 12 1

Pearson Correlation .315 FII (US $ million) Sig. (2-tailed) N .319 12

12
*

Pearson Correlation .917 BSE Sensex Sig. (2-tailed) N .000 12

.586 .045 12

12 1.000** .000 12

12 1

Pearson Correlation .917** CNX Nifty Sig. (2-tailed) N .000 12

.590* .043 12

12

**. Correlation is significant at the 0.01 level (2-tailed). *. Correlation is significant at the 0.05 level (2-tailed).

Impact of flow of FDIs and FIIs on BSE Sensex Multi regression OLS is used to analyze the data. Independent Variable: FDI and FII Dependent Variable: BSE SENSEX The table 3 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. R2, the coefficient of determination, is the squared value of the multiple correlation coefficients. The value of R2 is 0.939; it shows that the model explains 93.9% of the variation. In other words the dependent variables FDI and FII are able to explain around 93% 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 1.533 which is close to the 2.
Table 3:Model Summaryb Adjusted R Model R 1
a

Std. Error of Durbinthe Estimate Watson 1617.43301 1.553

R Square Square .926

.969 .939

a. Predictors: (Constant), FII (US $ million), FDI (US $ million) b. Dependent Variable: BSE Sensex

The ANOVA Table 4, 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 much is less than residual sums of squares, which indicates that around 93% 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.
Table 4:ANOVAb Model Sum of Squares Df Mean Square F Sig.

Regression 3.649E8 2 1.825E8 1 Residual Total 2.354E7 9 2616089.530 3.885E8 11

69.751 .000a

a. Predictors: (Constant), FII (US $ million), FDI (US $ million) b. Dependent Variable: BSE Sensex

Testing for Collinearity in the data Table 5 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 10 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

Table 5:Coefficientsa Un-standardized Coefficients Std. Model 1 (Constant) B Error Beta t Sig. Tolerance VIF Standardized Coefficients Collinearity Statistics

2468.217 802.984 .033 .813

3.074 .013 9.405 .000 .901 1.110

FDI (US $ .309 million) FII (US $ .153

.040

.330

3.823 .004 .901

1.110

million) a. Dependent Variable: BSE Sensex

The multiple regression equation of CNX Nifty and the independent variables FDI and FII are : BSE SENSEX=0+1(FDI)+2(FII) BSE SENSEX=2468.217+.309(FDI)+.153(FII) 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 BSE Sensex trend are independent. Ha1: Flow of FDIs in to India and BSE Sensex trend are dependent. The p-value related to FDI shown in table 5, is .000 less than 0.05 so null hypotheses Ha1 is not accepted. Hence it is concluded that Flow of FDIs in to India and BSE Sensex trend are dependent. FII: The null hypothesis and alternative hypothesis with respect to BSE Sensex and FII can be stated as follows: H02: Flow of FIIs in to India and BSE Sensex trend are independent. Ha2: Flow of FIIs in to India and BSE Sensex trend are dependent. The p-value related to FII shown in table 5, is .004 less than 0.05 so null hypotheses Ha2 is not accepted. Hence it is concluded that Flow of FIIs in to India and BSE Sensex trend are dependent.

Impact of flow of FDIs and FIIs on CNX Nifty Multi regression OLS is used to analyze the data. Independent Variable: FDI and FII Dependent Variable: CNX Nifty The table 6 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 0.924; it shows that the model explains 92.4% of the variation. In other words the dependent variables FDI and FII are able to explain around 94% the variation of the dependent variable (NIFTY). 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 1.597 which is very close to the 2.
Table 6:Model Summaryb Adjusted Model R 1 R Square R Square .929 .970a .942 Std. Error of the Estimate 466.00398 DurbinWatson 1.597

a. Predictors: (Constant), FII (US $ million), FDI (US $ million) b. Dependent Variable: CNX Nifty

The ANOVA table 7, 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. There 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.
Table 7:ANOVAb Model Sum of Squares df Mean Square F 2 1.579E7 9 217159.709 11 Sig.

1 Regression 3.158E7 Residual Total 1954437.378 3.354E7

72.723 .000a

a. Predictors: (Constant), FII (US $ million), FDI (US $ million) b. Dependent Variable: CNX Nifty

Testing for collinearity of the data Table 8 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.
Table 8:Coefficientsa Un standardized Standardized Coefficients Std. Model 1 (Constant) B Error Beta t Sig. Tolerance VIF Coefficients Collinearity Statistics

810.120 231.350 .009 .812

3.502 .007 9.574 .000 .901 1.110

FDI (US $ .091 million) FII (US $ .046

.012

.335

3.948 .003 .901

1.110

million) a. Dependent Variable: CNX Nifty

The multiple regression equation of CNX Nifty and the independent variables FDI and FII are : CNX NIFTY= 0+1(FDI)+2(FII) CNX NIFTY = 810.120+.091(FDI)+.046(FII) 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 in table 8, is .000 less than 0.05 so null hypotheses Ha3 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: H 04: 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 in table 8, is .005 less than 0.05 so null hypotheses Ha4 is not

accepted. Hence it is concluded that Flow of FIIs in to India and CNX NIFTY trend are dependent. Findings Of The Study The FDIs flow has shown increasing trend during the considered period of study except in the recent past two years and during 2002 to 2004. The flow of FIIs did not show one single trend during the considered period of study. The flow of FII is less than flow of FDI in to India except for three years i.e. from 2003 to 2006. There is a strong positive correlation between FDI & Sensex and FDI & nifty, and the correlation is significant at 1 percent level of significance. There is a moderate positive correlation between FII & Sensex and FII & nifty but the correlation is not significant at 1 percent level of significance. Flow of FDIs into India and BSE Sensex trend are dependent. Flow of FIIs into India and BSE Sensex trend are dependent. Flow of FDIs into India and CNX Nifty trend are dependent. Flow of FIIs into India and CNX Nifty trend are dependent.

Table 9:Summary of two models developed Independent Dependent R2 Beta Variable variable FDI 0.803 Sensex 0.939 FII 0.330 0.942 Nify FDI FII 0.812 3.948

p 0.000 0.004 0.000 0.003

*significance at 5 percent level of significance

Summary & 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. Table 9 presents the summary of the two models developed. 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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