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Foreign portfolio investments in India

IndianMoney.com Research Team | Posted On Tuesday, April 14,2009, 11:48 AM

Foreign portfolio investments in India

 

 

Foreign Institutional Investments in the Indian Stock Market

To aid foreign private capital flows in the form of portfolio investments, developing countries have been advised to expand their stock markets. It was recommended that these investments would help the stock markets directly through widening investor base and indirectly by convincing local authorities to improve the trading systems. While the precariousness associated with portfolio capital flows is well known, there is also a concern that foreign institutional investors might introduce distortions in the host country markets due to the force on them to secure capital gains.

In this circumstance, this article seeks to assess the significance of foreign portfolio investments in India relative to other major forms and to study the relationship between foreign portfolio investments and trends in the Indian stock market during the precedent four years.

The character of global capital flows to developing countries underwent noteworthy changes on many counts during the 'nineties. By means of the time the East Asian financial crisis surfaced, the overall size of the flows more than tripled. It stood at US$ 100.8 bn. in 1990 and rose to US$ 308.1 bn. by 1996. This increase was mainly due to the quick rise in the flows under private account that rose from US$ 43.9 bn. to 275.9 billion during the same period. In relation terms the percentage of private account capital flows increased from 43.55 to 89.55 % (Table1). At the same time, the Official Development Assistance (ODA) declined both in relative and absolute terms. All the main workings of the private account capital transfers, namely

  1. Commercial loans
  2. Foreign direct investments (FDI), and
  3. Foreign portfolio investments (equity and bonds) (FPI) Recorded significant increases.

Portfolio flows increased at a quicker rate than direct investments on private account. Consequently, starting with a low level of 11.16 %, the share of capital flows in the form of portfolio investments quadrupled to reach 37.22 % in 1996 reflecting the enhanced stress on private capital flows with portfolio investments forming the second important constituent of the flows during the 'nineties. In this procedure, multilateral bodies led by the International Finance Corporation (IFC) played a most important role.

Subsequent the East Asian financial crisis, originally there was a slow down followed, by a decline in private capital flows. At the same time as bonds and portfolio equity flows reacted quickly and declined in 1997, loans from commercial banks had dropped a year later in 1998. Turn down in FDI was also delayed. However, the fall in FDI was quite small compared to the other 3 major types of private capital flows. At the same time as flows on official account amplified, following the crisis, they continue to constitute only a small portion of the total flows. Accordingly, starting with the resolve by the developed countries to provide 1 % of their GNP as developmental aid, the industrialized world preferred to encourage private capital transfers in the course of direct investments instead of official assistance

The declining significance of official development finance is qualified to budgetary constraints in donor countries and the optimism of private investors in the capability of the developing countries

Table 1. Aggregate Net Long-term Resource Flows to Developing Countries (US$ bn.) 

 

Type of flow

1990

1991

1992

1993

1994

1995

1996

1997

1998

A. Official Flows

56.9

62.6

54.0

53.3

45.5

53.4

32.2

39.1

47.9

B.  Total Private Flows of which.

 

43.9

60.5

98.3

167.0

178.1

201.5

275.9

299.0

227.1

-International Capital Markets

19.4

26.2

52.2

100.0

89.6

96.1

149.5

135.5

72.1

- Private Debt Flows

15.7

18.6

38.1

49.0

54.4

60.0

100.3

105 3

58.0

- Commercial Banks

3.2

4.8

16.3

3.3

13.9

32.4

43.7

60 1

25.1

- Bonds

1.2

10.8

11.1

37.0

36.7

26.6

53.5

42.6

30.2

-Others

11.4

3.0

10.7

8.6

3.7

1.0

3.0

2.6

2.7

- Portfolio Equity Flows

3.7

7.6

14.1

51.0

35.2

36.1

49.2

30.2

14.1

Foreign Direct Investment

24.5

34.4

46.1

67.0

88.5

105.4

126.4

163.4

155.0

C. Aggregate Net Resource

100.8

123.1

152.3

220.2

223.6

254.9

30K. 1

338.1

275.0

Total Flows (C)

 

43.55

49.15

64.54

75.84

79.65

79.05

89.55

88.44

82.58

Share of Portfolio Capital Flows (equity+bonds) in

Private Flows (B)

 

11.16

30.41

25.64

52.69

40.37

31.12

17.22

24.35

19.51

Portfolio investments extend risk for foreign investors and provide an opportunity to share the outcome of growth of developing countries which are expected to grow faster. Investing in up-and-coming markets is expected to provide a better return on investments for pension funds and private investors of the developed countries. For developing countries, foreign portfolio equity investment has diverse characteristics and implications when compared to FDI (Foreign Direct Investment). Over and above, supplementing domestic savings, FDI is expected to smooth the progress of transfer of technology, introduce new management and marketing skills, and helps expand host country markets and foreign trade.

Portfolio investments supplement foreign exchange accessibility and domestic savings but are most often not project specific. FPI, are invited by developing countries for the fact, these are non-debt creating. FPI, if involved in primary issues, provides critical risk capital for new projects. In view of the fact that FPI takes the form of investment in the secondary stock market, it does not openly contribute to the creation of new production capabilities. To enable FPI flows which favor easy liquidity, multilateral bodies, led by the International Finance Corporation (IFC), have been cheering establishment and strengthening of stock markets in developing countries as a medium that will facilitate flow of savings from developed countries to developing countries.

FPI, it is predictable, could help achieve a higher degree of liquidity at stock markets, increase price-earning (PE) ratios and accordingly reduce cost of capital for investment. FPI is also anticipated to lead to improvement in the functioning of the stock market as foreign portfolio investors are believed to invest on the basis of well researched strategy and a realistic stock valuation. The portfolio investors are known to have highly knowledgeable analysts and access to a host of information, data and experience of operating in widely differing economic and political environments. Host countries looking for foreign portfolio investments are grateful to improve their trading and delivery systems which would also be a benefit for the local investors. To hold on to confidence of portfolio investors host countries are expected to follow consistent and business- friendly liberal policies. Having admittance to large funds, foreign portfolio investors can influence developing country capital markets in a significant manner especially in the deficiency of large domestic investors.

Portfolio investments have various macro- economic implications. While contributing to build-up of foreign exchange reserves, portfolio investments would influence the exchange rate and could show the way to artificial appreciation of local currency. This could harm competitiveness. Portfolio investments are agreeable to sudden withdrawals and as a result these have the potential for destabilizing an economy. The instability of FPI is significantly influenced by global opportunities and flows from one country to another. Although it is sometime argued that FDI and FPI are both equally volatile, the Mexican and East Asian crises brought into hub the higher risk involved in portfolio investments.

The FII has two objectives. First one, to evaluate the importance of different types of foreign portfolio investments in capital flows to India. And the second one, to understand the investment behavior of foreign portfolio investors in the course of an analysis of the portfolios of 5 US-based India specific funds. Such an exercise, it is hoped, would clarify the relationship between foreign institutional investments and trading pattern in the Indian stock market superior than aggregate level analysis.

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