A study on foreign institutional investment in India

Abstract

Foreign institutional investment is a topic that evokes both aversion and excitement in financialmedia. While they are condemned for causing volatility in the capital markets, they are praised forincreasing the depth in the market. This report is an attempt to look into the origins and reasonsbehind the flow of foreign capital funds to India, and its impact on the financial markets as well asthe real economy in India.FIIs for long has been studied using econometric methods which essentially treated it as a macrotime series and tried to find its relation with other variables like GDP growth etc. We look deeperinto the origins of the funds and find that the finds primarily originate either from hedge fundswhich have a short investment horizon or other institutional investors like pension funds, sovereignwealth funds etc. which are looking at a medium to long term horizon. The factors that attract thesetwo classes of investors are quite different and so are their behaviors. This has importantramifications for policy formulation for their regulation as well as measures to attract them.We also look into the impact of FIIs on Indian financial markets as well as the real economy. Weshow that FIIs have considerable impact on the volatility of financial markets but contributepositively in many ways like increasing the depth of the markets etc. When it comes to realeconomy, we show that the important contribution of FIIs is to provide increased capital availabilityto the primary markets. We also, based on data conclude that FIIs don't have a strong influence onactual investment demand in the economy.