Financial Resource

corporate entities from September 1992. Indian firms were allowed access to international capital markets through global depository receipts or Euro convertible bonds which converted debt into equity after stipulated period. This access, however, was not automatic. Individual applications, drawn up inconformity with the general guidelines of the government, were subject to approval. This process remains unchanged.

Offshore Funds:

An offshore fund is a collective investment scheme domiciled in an Offshore Financial Centre, for example British Virgin Islands, Luxembourg, Cayman Islands or Dublin.

Similar facilities for portfolio investment were subsequently extended to Offshore funds, non-resident Indians (as individuals) and overseas corporate bodies, only for investment in shares or debentures through stock exchanges, on the same terms as foreign institutional investors, but subject to a ceiling of 5 per cent for individual non-resident Indians or overseas corporate bodies in a single Indian firm.

Among the various components of portfolio investment, FII comprises the bulk of portfolio inflows. The main objective of foreign institutional investors is to minimize risk and maximize returns by diversifying their portfolios internationally. Major determinants of investment decisions of FII are country and region specific.

Portfolio flows often referred to as ‘hot- money’ are notoriously volatile capital flows. They have also responsible for spreading financial crisis causing contagion in international market. Evan though, the FIIs have been plying a key role in the financial markets since their entry into this country. The explosive portfolio flow by FII brings with them great advantages as they are engine of growth, lowering cost of capital in many emerging market. This opening up of capital markets in emerging market countries has been perceived as beneficial by some while others are concerned about possible adverse consequences.

Among the most active FIIs are Morgan Stanely Asset Management, jardine Fleming, Capital International, J. Henery schorder, templeton, Warburg Pinkers, Internatioanl Alliance and Quantum fund.

Foreign Institutional Investors in India

India opened her doors to foreign institutional investors in September, 1992. This event represents a landmark event since it resulted in effectively globalizing its financial services industry. Initially, pension funds, mutual finds, investment trusts, Asset Management Companies, nominee companies and incorporated/institutional portfolio managers were permitted to invest directly in the Indian stock markets. Beginning 1996-97, the group was expanded to include registered university funds, endowment, foundations, charitable trusts and charitable. Since then, FII flows which form a part of foreign portfolio investments have been steadily growing in importance in India. Other than in the year 1998, the net flows have been positive. The nuclear tests and East Asian crisis did slow down the flows but as stated by Gordan and Gupta (2003), their effects were short lived. That the percentage of total net turnover of BSE, the share of average of FII sales and purchases increased from 2.6 percent in 1998 to 5.5 percent in 2002. The cumulative net FII investment in India as on August 2003 is approximately 400 million. As of August 2003 net FII investment was 9 percent of the BSE market capitalization which is small compared to the size of the market. However, in the words of Banaji (2002), it is not the market capitalization that matters but what is important is the level of the free float, that is, the shares that are actually publicly available for trading. With floating stock in the Indian market being less than 25 percent, about 35 percent of the free float available has been bagged by FIIs – despite the fact that they invest in just a few highly liquid stocks.

Though India receives hardly 1 percent of the FII investments in emerging markets, the portfolio flows to India have been less volatile when compared with that of many other emerging markets (Gordan and Gupta, 2003). FIIs by adopting a bottom-up approach seem to invest in top-quality, high growth, large cap stocks (Gordan and Gupta, 2003). Sytse et al. (2003) provide empirical evidence that foreign institutional investors in India, invest in large, liquid companies which enable them to exit their positions quickly at relatively lower cost and also that the foreign institutional owners have a larger impact than foreign corporate owners when performance is measured using stock market valuation criterion.

India is one of the fastest growing economies in South Asia, promising a growth of over 9 percent, second only to China, it would not be a surprise to see increased FII flows to India in the future. FIIs are now looking at the economy as a whole, with the macro-economic factors also playing their role in attracting foreign investors. Factors like a strong currency, key reforms in the banking, power and telecommunications sector, increased consumer spending and stable policies are expected to play a major role in attracting FIIs to India. The Securities Exchange Board of India (SEBI) along with the Institute of Chartered Accountants of India (ICAI) jointly monitor the markets and announces the regulatory measures thus making the Indian companies more transparent and more disciplined.

According to the April 2005 report on corporate governance by CLSA Emerging Markets, India ranks fourth with a score of 55.6 percent. Banaji (2000) emphasizes 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 capital market reforms. The market reforms were initiated because of the presence of FIIs and this in turn has lead to increased flows.

The Government of India gave preferential treatment to FIIs till 1999-2000 by subjecting their long term capital gains to lower tax rate of 10 percent while the domestic investors had to pay higher long-term capital gains tax. The Indo-Mauritius Double Taxation Avoidance Convention 2000 (DTAC), exempts Mauritius-based entities from paying capital gains tax in India – including tax on income arising from the sale of shares. This gives an incentive for foreign investors to invest in Indian markets taking the Mauritius route. Consequently, we now see investments coming from Mauritius while there were none before 2000.

The country wise distribution of the FIIs registered in India, with majority of them coming from USA and UK. Chakrabarti (2002) and Rao et al. (1999) point out the fact that due to existing inter-linkages, the source of the FII investment might not be the country from where the institution operates. Nevertheless, the figure gives us an idea of the country wise distribution of the FIIs in India. So as to encourage long term investments in the Indian market, Budget 2003 proposed that investors who buy stocks of listed companies from March 1, 2003 be exempt from paying tax on the gains they make on their investments, provided they hold them for more than one year. With so much to benefit from, the FII investment in India is likely to increase in the future.

Regulation on FII

Investment by FII was jointly regulated by Securities and Exchange Board of India (SEBI) through the SEBI (Foreign Institutional Investors) Regulations, 1995 and by the Reserve Bank of India through Regulation 5(2) of the Foreign Exchange Management Act (FEMA), 1999. The promulgation of legislation pertaining to foreign investment by SEBI in 1995 market a watershed for FII flows to India; this led to a significant increase in the level of FII equity inflows in the pre-Asian crisis period. The SEBI FII Regulations and RBI policies are amended and modified from time to time in response to the gradual maturing of the Indian financial market and changes taking place in the global economic scenario.

In order to trade in India equity market, foreign corporation need to register with SEBI as Foreign Institutional Investors. Without registration they can invest, but cases require the approval from RBI. They are generally concentrated in secondary market. FII are allowed to invest in

a) Securities in primary and secondary market including shares, debentures and warrant of companies, unlisted, listed or to be the listed in India.

b) Units of mutual funds

c) Dated government securities

d) Derivative traded in a recognized stock market and

e) Commercial papers

FII can invest their own funds as well as invest on behalf of their over seas clients registered as such with SEBI. These client accounts that the FII manages are known as ‘sub accounts’. FII sub accounts include those foreign corporate, foreign individual, institution funds or portfolio established or incorporated out side India.

FII may issue deal in or hold off share derivative instrument such as participatory notes (PN). The entities that can subscribe to the PN are : a) Any entity incorporated in a jurisdiction that requires filing of constitutional or other documents with a registrar of companies or comparable regulatory agency or body under the applicable companies legislation in that jurisdiction; b) Any entity that is regulated, authorized or supervised by a central bank, such as

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