FII flows in Indian equity markets: boon or curse?

Abstract

Cross-border capital flows can have significant real effects. For instance, during the early 1990s, several East Asian countries experienced significant amounts of capital flows into their markets; subsequently however, they faced a sudden reversal of capital flows in 1997. The currency and stock markets of Indonesia, Thailand, Malaysia, Philippines, and South Korea suffered a major decline due to the flight of capital to safety. Although capital flows reverted to original levels by 1999, during the interim period (1997–1999), the crisis spread from East Asia to Latin America, leaving many developing countries in a state of recession. The initial symptoms of flight of capital are often associated with excessive shortterm volatility. The debate about the perils of capital flows, thus, rests on gaining a better understanding of the precise impact of foreign fund flows on the short-run volatility in domestic financial markets. Not much empirical research has been done, however, to gauge the magnitude as well as the longevity of the impact of capital flows on equity markets. In this study, we fill this gap by examining how foreign institutional investor (FII) flows into India affect the performance of the domestic equity market in terms of both the magnitude of the immediate impact as well as the permanence of the impact.