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Executive Summary

FIIs share in the Indian capital markets has shown a steady increase from US$ 200 million in 1991-92, to $8.8 billion in 2004. This marked growth in FII is due to the financial liberalization policies followed by India from 1991 onwards. This buoyant foreign investment flows into the country have continued to demonstrate the high level of confidence that the international investors repose in the Indian economy.
A number of new FIIs and FII sub-accounts got registered in 2004. The most significant new FII registered in 2004 is California Public Employees Retirement Plan (CalPERS) - the largest pension fund in the US. CalPERS, which has assets totaling $ 162 billion under its management, has already started investing in the Indian market. One reason for the surge in FII inflow is the strengthening of the rupee against the US dollar. The strengthening of the rupee is due to the weakening of dollar across global currencies. Until about two years ago, FIIs used to bear losses on their portfolio investment when the rupee would continuously depreciate. With the rupee strengthening, that's not the case now.

Debate about FII being "the hot money"

Given the perception about FIIs as market leaders in the domestic stock market, the increasing importance of FII trading at the margin and the dominant position of FIIs in the Sensex companies, we can understand that FIIs are in a position to influence the movement of Sensex in a significant way. The influence of FIIs on the movement of Sensex became apparent after the general election in India when the sudden reversal of FII flows triggered a panic reaction, which resulted in very high volatility in the Indian stock market. During this period, the Sensex experienced its worst single-day decline in its history and in the three-month period between April to June 2004, it declined by about 17 percent. And it all started because of the selling pressure exerted by the FIIs after the post election phase when they became less confident about the continuation of reform process in India.

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* Contributed by -
Subhasree Chakraborty & Ambar Roy,
Department of Management Studies,
IIT Delhi.