How can FIIs boost the Indian economy

A foreign institutional investor (FII) is an investor or an investment fund registered in the country other than it is investing in. They play a vital role in any economy. Primarily, institutional investors include investing in hedge funds, insurance companies, pension funds and mutual funds investment. The term is common in India and refers to outside companies investing in India’s financial and capital markets. These investors can also include banks, large corporate buyers or representatives of large institutions. 

The Reserve Bank of India’s Portfolio Investment Scheme (PIS) enables NRIs and OCBs to purchase and sell shares and convertible debentures of Indian companies. It can be done on a recognised stock exchange by routing purchase/sale transactions through their NRI Savings Account with a designated bank branch.

FII in India

From 1992 to 1993, there was a significant increase in FII or FPI investment. Since liberalisation, many things have changed in India, particularly in the Indian capital markets that see a large amount of foreign capital. For the first 4-5 years, the most significant inflows were in the equities sector, i.e., stock market inflows. Fixed security investments began in 1996-1997 when FIIs began investing in fixed income securities and debentures of Indian companies, as well as government assets. For the first time, negative flows were seen in 1998-99. The cause of this was the Asian currency crisis. Then this inflow and outflow of funds continued, with a few years seeing outflows and a majority seeing inflows. 2014-15 was an election year with a strong government with a full majority at the centre. That year we saw the highest flows in India, amounting to almost Rs. 2,77,460 crore. 2017-18 was a positive year, with the debt market being the net attracter and having investment worth 1,19,036 crore rupees.

Then in 2021, we saw overseas investors close the year with an inflow of around Rs 51,000 crore, down 70  per cent, against Rs 1,70,260 crore in 2020, which was a steep fall mainly due to the threat of tapering by the US fed, which led to a record outflow in the last quarter of FY 2021. Recently, FIIs have been on a selling spree across most emerging markets, including India. They have sold over $11 billion worth of equities since October 2021 and $7 billion in FY 22 till February 2022.

What causes inflow and outflow of FII 

The major factors that drive the inflows of funds through FIIs into an emerging market like India are global liquidity and the macro environment. Global liquidity plays a vital role; liquidity rises when central banks reduce short term interest rates. This makes money readily available to them, which leaves them with enough money to invest in capital markets, securities and debentures of Indian companies. The strong macro environment will mean a robust economy where valuations are attractive, which will mean a higher rate of return for the FIIs. And many FIIs in western or developed countries are also investing in emerging markets of countries like India through portfolio investment schemes (PIS) or other ways because the return on different instruments is higher in developing countries compared to developed countries. For example, a 10-year bond yield in the US is 2.71% in April 2022, while that of an Indian bond is 6.90%. While investing, they also look for a stable currency because an unstable currency also makes the company look for ways to hedge their currency risk.

Impact of FIIs on stock and debt market

The investment decisions of FIIs have a profound impact on the Indian capital markets and the economy in general. A healthy flow of FIIs leads to a rise in various market Indexes, which means more money flowing into various instruments like equities, bonds, and debentures of Indian companies and the government. This is more money in the hands of the government and companies to invest in their operations and growth, thus reducing budget gaps, which would eventually mean the growth of the economy in general. FIIs also contribute to the development of various market instruments. FIIs usually invest in these instruments through portfolio investment schemes (PIS), which eventually improves the overall efficiency of the markets. 

In the case of direct investment, FIIs can also contribute by lending their understanding of a firm’s operations, financial analysts and asset managers constituting FIIs improve corporate governance. Yet FIIs are generally limited to a maximum investment of 24% of the paid-up capital of the Indian firms. In cases where they have special permission, they can go above it, but these conditions are placed to restrict or control their influence on Indian firms and Indian markets.

Advantages

FIIs help boost capital inflows into the country, and their investment in our stock markets will help us sustain and improve our capital structure. FIIs investing in equity has been in line with the accepted preference for non-debt creating foreign inflows over foreign debt. It also helps improve capital structures and contributes toward building the investment gap. They also positively impact financial market competition and contribute toward capital market innovation. By increasing the availability of riskier long term capital for projects and increasing firms’ incentives to provide more information about their operations, FIIs can help in economic development. 

FIIs constitute professional bodies of asset managers and financial analysts, who, by contributing to a better understanding of firms’ operations, improve corporate governance. Bad corporate governance makes equity finance a costly option. Also, institutionalisation increases dividend payouts and enhances productivity growth. All these investments coming into India will also provide capital to companies and the government, allowing them to spend more on operations and expansion, resulting in more jobs and economic growth.

Disadvantage

The native currency (rupee) being in higher demand will make RBI pump in more money, resulting in a significant increase in the economy’s inflation rate. The FIIs profit from investing in emerging financial stock markets. With huge amounts of funds in the country’s stock markets, they have a great influence on the way the stock markets behave, going up or down. FII flows also lead to an appreciation of the currency, which may lead to the exports industry becoming uncompetitive due to the appreciation of the rupee. Investors who tend to invest for a short period inject money into a country, which leads to the exchange rate for the country gaining the money strengthening, while the exchange rate for the country losing the money weakens. If money is withdrawn on short notice, the banking institution will experience a shortage of funds.