PROJECT

IMPACT OF
EMPHERICAL
FINANCE
FII ON
CAPITAL
MARKET

BY:
Kunal Jain
(2009161)
Priyanka Talwar Submitted to : Prof. S.K. Mitra
(2009189)
Rajnikant Bajaj
(2009190)
INTRODUCTION:

Foreign investment refers to investments made by the residents of a country in the financial
assets and production processes of another country. The effect of foreign investment,
however, varies from country to country. It can affect the factor productivity of the recipient
country and can also affect the balance of payments. Foreign investment provides a channel
through which countries can gain access to foreign capital. It can come in two forms: foreign
direct investment (FDI) and foreign institutional investment (FII). Foreign direct investment
involves in direct production activities and is also of a medium- to long-term nature. But
foreign institutional investment is a short-term investment, mostly in the financial markets.
FII, given its short-term nature, can have bidirectional causation with the returns of other
domestic financial markets such as money markets, stock markets, and foreign exchange
markets. Hence, understanding the determinants of FII is very important for any emerging
economy as FII exerts a larger impact on the domestic financial markets in the short run and a
real impact in the long run. India, being a capital scarce country, has taken many measures to
attract foreign investment since the beginning of reforms in 1991.

India is the second largest country in the world, with a population of over 1 billion people. As
a developing country, India’s economy is characterized by wage rates that are significantly
lower than those in most developed countries. These two traits combine to make India a
natural destination for foreign direct investment (FDI) and foreign institutional investment
(FII). Until recently, however, India has attracted only a small share of global foreign direct
investment (FDI) and foreign institutional investment (FII), primarily due to government
restrictions on foreign involvement in the economy. But beginning in 1991 and accelerating
rapidly since 2000, India has liberalized its investment regulations and actively encouraged
new foreign investment, a sharp reversal from decades of discouraging economic integration
with the global economy.

This research project studies the relationship between FIIs investment and stock indices. For
this purpose we selected India’s two major indices i.e. Sensex and S&P CNX Nifty. These
two indices, in a way, represent the picture of India’s stock markets. We also selected the five
industry specific indices of BSE i.e. BSE CD, BSE CG, BSE FMCG, BSE HC and BSE IT so
as to further observe the effect of FII on particular industry. So this project reveals the impact
of FII on the Indian capital market.
There may be many other factors on which a stock index may depend i.e. Government
policies, budgets, bullion market, inflation, economic and political condition of the country,
FDI, Re./Dollar exchange rate etc. But for my study I have selected only one independent
variable i.e. FII. This study uses the concept of correlation and regression to study the
relationship between FII and stock index. The FII started investing in Indian capital market
from September 1992when the Indian economy was opened up in the same year. Their
investments include equity only. The sample data of FIIs investments consists of monthly
average from January 1993 to September 2001 with 105 observations.

Data Collection:

 The research will be done with the help Secondary data (from internet site and
journals).
 The data is collected mainly from websites, annual reports, World Bank reports,
research reports, already conducted survey analysis, database available etc.

Objective: The objective of my research is to find the relationship between the FIIs
investment and stock index. We have also analysed the impact of FII on specific industrial
sector indices.

Null Hypothesis (Ho): The various BSE indices and S&P CNX Nifty index does not rise
with the increase in FIIs investment.

Hypothesis (H): The various BSE indices and S&P CNX Nifty index rises with the increase
in FIIs investment.

RESEARCH DESIGN

Problem: What is the impact of FIIs investment on the Indian capital market?

Hypothesis: The various indices of BSE and NSE Nifty rises with the increase in FIIs
investment.

What to observe?

For my research purpose we selected six indices of BSE i.e. Sensex, BSE CD, BSE CG, BSE
FMCG, BSE HC and BSE IT and one index of NSE i.e. S&P CNX Nifty. The sample data of
FIIs investments consists of the monthly average from January 1993 to September 2001 with
105 observations. The sample data of Nifty and Sensex consists of the monthly closing index
January 1993 to September 2001 with 105 observations while the past three years data has
been taken for other BSE indices with 33 observations in each case.

How to observe?

The data regarding indices of BSE was taken from the site of BSE and BSE yearbook 2001.
We got the data on FIIs investment from Reserve Bank of India’s site. The data of NSE Nifty
index was obtained from the site of national stock exchange. Other financial sites,
newspapers and magazines helped me in collecting the required data.

How to record observation?

We have taken the monthly closing index of all the indices. For FIIs I have recorded monthly
average of the net investments made by them in the Indian capital market.

Net Investments = Purchases – Sales

Model: A simple linear relationship has been shown between two variables using correlation
and regression as the data analysis tools. One variable is dependent and the other is
independent. We have taken FII as the independent variable while the stock index has been
taken as dependent variable. The impact of FII has been separately analyzed with each of the
index. So, correlation and regression has been separately run between FII and seven indices
taking one index at a time.

Inference: If the hypothesis holds good then we can infer that FIIs have significant impact on
the Indian capital market. This will help the investors to decide on their investments in stocks
and shares. If the hypothesis is rejected, or in other words if the null hypothesis is accepted,
then FIIs will have no significant impact on the Indian bourses.

RESEARCH METHODOLOGY

Models:

Regression Analysis: This analysis tool performs linear regression analysis by using the
"Least squares" method to fit a line through a set of observations. We can analyse how a
single dependent variable is affected by the values of one or more independent variables —
for example, how an athlete's performance is affected by such factors as age, height, and
weight. We can apportion shares in the performance measure to each of these three factors,
based on a set of performance data, and then use the results to predict the performance of a
new, untested athlete.

Correlation: This analysis tool and its formulas measure the relationship between two data
sets that are scaled to be independent of the unit of measurement. The population correlation
calculation returns the covariance of two data sets divided by the product of their standard
deviations. We can use the Correlation tool to determine whether two ranges of data move
together — that is, whether large values of one set are associated with large values of the
other (positive correlation), whether small values of one set are associated with large values
of the other (negative correlation), or whether values in both sets are unrelated (correlation
near zero).

Data: The sample data consists of 105 observations for FII, Sensex and S&P CNX Nifty
starting from January 1993 to September 2001. The sample for other five indices of BSE
consists of 33 observations starting from January 1999 to September 2001. I have taken the
monthly closing index of all the indices and monthly average of net investments made by FII.
The FIIs started investing in Indian capital market from September 1992. The numbers of
scripts under following index are:

BSE Sensex – 30

NSE Nifty – 50

BSE Consumer Durables (CD) – 22

BSE Capital Goods (CG) – 49

BSE Fast Moving Consumer Goods (FMCG) – 44

BSE Health Care (HC) – 48

BSE Information Technology (IT) – 42

FII was taken as independent variable. Stock indices were taken as dependent variable. The
data was taken from various financial sites.
FINDINGS

The findings for the data sample after applying correlation and regression:

Correlation with FII Multiple R R-Square Standard Error

NSE Nifty 0.307 0.302 0.0915 221.1
BSE Nifty -0.017 0.017 0.0003 319578.2
BSE CD -0.011 0.0111 0.0001 379.6
BSE HC 0.003 0.0067 0 301
BSE FMCG -0.047 0.0511 0.0026 130.6
BSE CG -0.017 0.0995 0.0099 233.9
BSE IT 0.236 0.2302 0.0523 1392.3

RESULTS

1. Impact of FII on Nifty: The effect of FII on Nifty is positive. But the co-efficient of
correlation is low so the effect is less. The standard error comes out to be 221.1which is high.
This does not mean the relation is false but we can say that the error in linear relation is high.

2. Impact of FII on BSE Sensex: The effect of FII on Sensex is negative. So, FII is inversely
related to Sensex. But the co-efficient of correlation is very low so the effect is very less. The
standard error comes out to be 319578.2which is very high. This means that the deviation
from the mean value is high. This does not mean the relation is false but we can say that the
error in linear relation is high. The value of multiple-R is also very less. We can say that FII
did not have any significant impact on Sensex during the period of January 1993 to
September 2001.

3. Impact of FII on BSE CD: BSE CD is inversely related to FII for the period of January
1999 to September 2001. But the extent of impact is very-very low as co-efficient of
correlation is -0.011.

4. Impact of FII on BSE HC: FII has no significant relation with BSE HC, as the value of
correlation is 0.003. This does not mean that there is no relation at all between them. It shows
the absence of linear relation between the two variables but not a lack of relationship
altogether.
5. Impact of FII on BSE FMCG: BSE FMCG is inversely related to FII for the period of
January 1999 to September 2001. But the value of R is low so the degree of relation is low.
Standard error in this case is 130.6which is less compared to other standard errors between
FII and other stock indices.

6. Impact of FII on BSE CG: BSE CG is also negatively correlated with FII. In this case
again the degree of relation is less.

7. Impact of FII on BSE IT: BSE IT is positively correlated with FII for the period of January
1999 to September 2001.The value of correlation is 0.236.

CONCLUSION

According to findings and results, I concluded that FII did not have any significant impact on
the Indian capital market. Therefore, the null hypothesis is accepted. BSE IT and Nifty
showed some positive correlation but rest of the index showed negative correlation with FII.
Also the degree of relation was less in all the case. It shows the absence of linear relation
between FII and stock index. This does not mean that there is no relationship between them.

One of the reasons for absence of any linear relation can also be due to the sample data. The
data was taken on monthly basis. The data on daily basis can give more positive results
(maybe). Also FII is not the only factor affecting the stock indices. There are other major
factors that influence the bourses in the stock market. I also analysed that FII had significant
impact on the stock index for the period starting from January 1997 to December 1999. This
shows that FII did not have any significant impact earlier but later on they played an
important role in the stock market. The sample data available for sectoral indices was low
with just 33 observations that have also hampered the results.