The Role of FII in India: Key to Indian Economic Growth

Foreign Institutional Investors, known as FIIs are those investors who invest in the securities of foreign countries. For Example, If an investor from the USA invests in the stock market of India, then they will be considered as FII. FIIs can be of different types like Sovereign Wealth funds, Foreign Government Agencies, International Multinational Organisations, and Foreign Central Banks.

FIIs can be pension funds, mutual funds, investment trusts, asset management companies, banks, institutional portfolio managers, charitable trusts, or charitable societies of foreign countries.

FII in India

Most of the FIIs belong to developed countries like the US etc. These countries are already developed and have very few growth opportunities. Thus FII always looks for developing nations that have more growing potentials. India is the perfect spot for FII as India is increasing and can provide higher returns in upcoming years. For Investing in India, FIIs must register with SEBI(Securities and Exchange Board of India).

History of FII in India

After seeing better opportunities in 1992, FIIs entered the Indian Market. They were constant buyers from 1992 to 1997. The amount FIIs have invested increases with the flow of years. They have withdrawn their money only during any crisis. For example, during the Lehman Crisis FIIs were the main reason for making things worse for the Indian Stock Market.

Political conditions are always the first reason to see significant changes in foreign cash flows. After the BJP’s major victory in the Central Election, A huge amount of money entered the Indian market through FIIs. We have seen a huge rally in recent years due to FIIs activities.

Impacts of Foreign Institutional Investors(FIIs)

FIIs generally come from developed and rich economies with an abundance of cash reserves. Though their main purpose is to generate good returns, they catalyzed market activities in India.

• Market Volatility and Liquidity

FIIs are always the major source of increasing market volatility. Their investment decisions can impact the market reactions, affecting specific sectors and liquidity in the Market. When FIIs pour money, it rallies the Indian Capital Market Index. Meanwhile, a drop in FII cash flow can decrease in Indian Market Index

FIIs generally participate in buying and selling activities and can impact the liquidity in the Stock Market. Sudden FII activities can fluctuate the market, and impact market sentiments and stability of the market.

• Economic Growth and Capital Inflows

Foreign Institutional Investors(FII) have a big impact on how the money comes into the country and how the economy grows. FIIs invest their money in different sectors like energy, IT, pharma, and others.

This implies increased employment opportunities, improved quality of work, and contributes to the overall strength and development of the nation. The foreign money brought by FIIs adds to the host country’s savings of foreign money. This is important for keeping the value of money steady and paying for things the country owes other countries.

• Influence on Stock Prices and Exchange Rates

FIIs have a big impact on the Indian Stock Market. When Foreign Institutional Investors put money into a country’s stock market, it can cause stock prices to rise. But if they take out a lot of money, the prices can go down. Their actions are a big deal for how the stock market moves.

In recent years, FIIs have been responsible for a significant portion of the trading volume in many emerging market stock exchanges. For example, In India, FIIs have been known to account for over 20% of total market activity on several occasions.

Similarly, their impact on exchange rates can be observed in instances where substantial FII transactions have led to noticeable fluctuations in the value of the host country’s currency

• Impact on local businesses and industries

Foreign Institutional Investors can affect local businesses and industries. If FII invests in local businesses, they will have a better opportunity to grow. It helps them to increase the rate of production and run better. If FII is putting money in a small business then there are very high chances that their stock prices will go up.

In South Korea and Brazil, FIIs have invested in local businesses like technology, finance, and energy which has positively impacted the performance and growth of these sectors.

Reason for selling by FIIs

FII selling can sometimes create a panic environment in the share market. Several reasons are responsible for FIIs selling:

•  Rising Interest Rates

During Inflation, Central Banks Increase the interest rates to try and stop the inflation before it becomes a big problem. This means the stock market has to get used to high interest rates. This is not good for developing countries like India. When interest rates go high in developed nations, FIIs go back to those countries as they are seen as safer and pull out their money from the market of growing nations.

• Depreciating Rupees

The rupee has fallen compared to other emerging markets, but it’s not as much. However, we have seen a big drop in the value of Rupee. In September 2021, it was 73 rupees for one dollar. By October 2022, it went down to 83 rupees for one dollar. There is a significant decrement of 12% in 13 months.

This is a big problem for any FII from a different country that has invested in India. If their investment didn’t go up in value by at least 12% during this time, they would lose money. During this time, Indian stocks were falling. So FIIs faced their losses from both sides- Stocks and the currency. These were the reason they were selling the shares in India and taking money back to the USA and other developed countries.

• Profit Booking

Profit Booking can impact market volatility as their large sales can put downward pressure on the market.  FIIs’ profit booking can influence overall investor sentiment, potentially leading to a bearish outlook and affecting the confidence of domestic retail and institutional investors.

One example of profit booking by Foreign Institutional Investors (FIIs) in the Indian stock market occurred in 2021 when FIIs engaged in significant selling activities, leading to profit booking. This led to a considerable drop in funds from the Indian markets as FIIs sought to realize profits on their previous investments.

During this period, FIIs sold off holdings in various sectors, including banking, IT, and pharmaceuticals, contributing to a drop in stock prices and market indices. This profit-booking activity by FIIs had a notable impact on market sentiment, and liquidity, and contributed to increased market volatility during that time. 

We have seen during any crisis FIIs used to remove their money and the Indian stock market falls like the flash of cards. However, in recent years, things have changed a lot. Since Retail involvement is increased, Mutual funds and Domestic Institutional Investors(DII) can support the market and avoid the sharp fall due to the selling of FIIs.

Future of FII Investments

Multiple reasons support FIIs buying in the Indian Stock Market.

• Rise in Exports

India’s exports have been growing continuously. In March 2022 exports set a record high of USD 40.38 billion, a 14.53% increase from March 2021. During this period, petroleum products exports grew by over 104.39%. Seeing this growth in exports, FIIs are more likely to continue their investment in the future.

• Strong GDP Projections

India’s GDP is growing continuously. India’s GDP growth for FY 2023-24 is projected at 6.1% for Q1, and 7.8% for Q2, according to the Reserve Bank of India (RBI). This projection is based on factors like the recent Market Rally, lower crude oil prices, and increased productive capacity due to government investments. These positive economic indicators make India an attractive investment destination for FIIs.

• Positive Government Reforms

The Indian government has implemented business-friendly policies and initiatives such as ease of doing business, Make in India, and digitalization. The Union Budget of 2022-23 includes measures like PM GatiShakti, production-linked incentives (PLI) for various industries, and a 27% expected rise in effective capital expenditure. These initiatives create a conducive environment for FIIs to invest in India.