Download Impact of FIIs on Trading Quantity and Market Capitalization of

7
Impact of FIIs on
Trading Quantity and Market
Capitalization of Indian Stock Market
7.1 Background
For developing countries, foreign portfolio equity investment has different
characteristics and implications compared to foreign direct investment (FDI). Besides
supplementing domestic savings, FDI is expected to facilitate transfer of technology
to introduce new management and marketing skills and to extend host country‟s
markets and foreign trade. FPI, on the other hand, supplements foreign exchange
availability and domestic savings but are not often project specific. Foreign
institutional investments in the form of portfolio investments are welcome by the
developing counties as this is non-debt creating. It is expected that FPI leads to
improvement in the functioning of the stock markets, which in turn results into
increased trading volume and market capitalization as foreign portfolio investors
intend to invest on the basis of well-researched strategies and realistic stock valuation.
Further, it is believed, foreign institutional flows could help on achieving a
higher degree of liquidity at stock markets, to increase price earning (P/E) ratios and
consequently to reduce cost of capital for investment. The lower cost of capital and
booming stock market can encourage new equity issues. Foreign portfolio
investments provide investors with an array of assets with varying degree of risk,
return and liquidity. The increased choice of assets and existence of vibrant equity
markets provides savers with more liquidity and options. The above in turn results in
augmenting households savings directed towards stock markets. The liquid markets
can improve the allocations of capital and can enhance prospects for long term
economic growth. Generally, FIIs concentrate on secondary markets. A strong
secondary market, besides providing liquidity to primary markets, allows the efficient
firms to price their new issues at a premium. Moreover, increased competition from
foreign institutional investors also paves the way for the derivatives market.
India faced debt crisis in the late 1980‟s and the balance of payments crisis in
1990-91. These two problems led to the third one i.e. shortage of investible resources.
All this compelled Indian government to initiate financial liberalization programme.
Along with the series of these reforms, the foreign investments regime was also
liberalized to a great extent. Lalitha (1992) states that attracting foreign capital
appeared to be the main reason for opening up the stock markets for foreign
institutional investors. In recent years, FIIs have displayed a strong appetite for India
as shown in Table 7.1. This table indicates that FIIs net investments increased to 2432
million dollar in 1996-97, but after the Asian crisis, these got a negative sign and
stood at -386 million $. However, there has never been a looking back thereafter and
FIIs net investment in India
TABLE 7.1 FOREIGN PORTFOLIO INVESTMENTS IN INDIA
(US $ MILLION)
YEARS
ADRs/GDRs
FIIs
Offshore Funds
Total
and Others
1992-93
240
4
3
247
1993-94
1,520
1,634
382
3,536
1994-95
2,082
1,528
239
3,849
1995-96
683
2,036
56
2,775
1996-97
1,366
2,432
20
3,818
1997-98
645
1,650
204
2,499
1998-99
270
-386
59
-57
1999-00
768
2,339
123
3,230
2000-01
831
2,159
82
3,072
2001-02
477
1,846
39
2,362
2002-03
600
562
2
1,164
2003-04
459
9,950
-
10,409
2004-05
613
10,248
16
10,877
2005-06
2,552
9,332
14
11,898
- 126 -
2006-07
3,776
6,626
2
10,404
2007-08*
2,785
15,508
108
18,391
Source: RBI Bulletin December 2007
*Data is upto September 2007
rose to 10248 million dollar in year 2004-05. Net investments went up further and
were recorded at 15508 million dollar for the duration April 2007 to September 2007.
GDRs/ADRs reached to US $ 2082 million in 1994-95 from 240 million in 1992-93.
However, as the FIIs gained momentum in 1995-96, GDRs/ADRs lost their signing
and came down as low as 683 million US $ in this year. During the last 10 years, the
funds flowing through this route (ADRs/GDRs) have fluctuated between 270 million
to 831 million US $. The various forms of foreign portfolio investments combinedly
worked out the lowest (US $ -57 million) in 1998 -99 and the highest (US $ 18391
million) in 2007-08. we can note from the table under reference that India has
succeeded in attracting constantly more than $ 10000 million of foreign capital in the
form of portfolios investments in each of the last five years. The same is further
supported by the share holding pattern as available in Table 7.2. Obviously, FIIs have
snatched more than 10 percent share in total shareholding in case of majority of the
industries in India. In some sectors such as banking, finance, media and entertainment
FIIs hold more than 15 percent of the equity shares. However, their share in the
equities of petrochemical, infrastructure and manufacturing sector is not so much
encouraging.
Based on the above theoretical framework it become imperative to investigate
the influence of FIIs arrival on Indian stock market in general, and on its
liquidity/turnover and market capitalization in particular. This chapter of our study is
a step towards the same. More specifically, here an attempt has been made to analyze
the Indian stock market development in terms of market capitalization, turnover, P/E
ratio etc. since the opening of India‟s stock markets for FIIs participation. Beside,
studying the role of FIIs in stock market development, the cause and effect
relationship between volume, market capitalization and foreign portfolio investment
has been determined.
7.2 Scope, Database and Methodology
- 127 -
This study covers a time period of 15 years from January 1993 to August
2007 so as to measure the impact of FIIs on trading volume and market capitalization
of India‟s stock market. Monthly basis data of the Trading Volume and market
capitalization have been taken from the website of the Reserve Bank of India to
achieve the objective of work. We have taken the monthly data of the purchases and
sales of securities by FIIs for the analysis. It needs mention that India witnessed
multi-billion rupee stock market scam in March 2001, which led to a freeze on the
flagship scheme of Indian largest mutual fund (Unit Trust of India) in June 2001.
Resultantly, the market
- 128 -
TABLE 7.2: SHARE HOLDING PATTERN AT THE END OF MARCH 2007 IN INDIA
(In percentage)
Banks
Indian
Foreign
Promoters
Promoter
Banks
43.79
1.02
4.76
18.41
3.59
Engineering
24.31
2.80
11.00
11.45
Finance
37.76
2.43
10.20
FMCG
16.27
16.19
IT
40.84
Infrastructure
Venture
Shares
Others
Bodies
Institution
Corporate
0.59
0.54
8.27
13.27
0.79
4.98
10.24
0.00
0.35
8.44
22.53
7.89
0.99
18.18
2.06
0.00
3.17
6.70
16.81
2.54
0.13
13.92
11.91
7.79
0.00
0.00
3.61
14.79
14.64
0.69
6.00
2.02
14.53
2.82
2.69
0.34
6.19
17.52
3.19
3.86
80.63
1.15
2.98
7.15
1.18
0.04
0.00
2.00
4.24
0.53
0.10
Manufacturing
44.70
9.98
6.85
9.57
3.79
0.16
0.09
5.95
15.44
1.95
1.51
Media & Ent.
39.05
5.64
2.17
15.20
5.93
0.00
0.00
7.75
21.31
2.82
0.14
Petrochemicals
57.78
8.18
5.06
5.83
1.46
0.00
0.87
5.50
10.53
0.60
4.19
Pharmaceuticals
40.44
8.20
4.88
11.17
3.41
0.24
0.46
6.12
21.04
2.38
1.67
Services
47.07
4.19
6.87
13.09
5.22
0.63
0.05
6.35
14.30
2.02
0.22
Telecom
56.72
3.17
3.31
11.17
1.62
4.37
0.00
3.20
10.11
5.47
0.86
Miscellaneous
41.85
2.44
3.54
8.19
3.39
0.00
1.51
10.56
24.12
3.06
1.33
48.08
6.87
5.85
10.78
3.23
0.63
0.42
5.60
13.78
2.76
2.01
Category
% to total
Shareholding
/Financial
FIIs
Inst./Govt
Mutual
Funds
Source: Indian Security Market – A Review, 2007
129
Capital
Funds
Individuals
Others
held by
Custodians
witnessed a considerable decline in trading volume at stock market. This abnormality
could prompt any researcher to remove outlier and then measure the impact of FII
investments on trading volume of Indian stock market. So we have ignored the time
period from March 2001 to June 2001 in the calculation of the impact of foreign
institutional investments on the Indian stock market‟s trading volume and market
capitalization. However, it is not denied that stock market scams are results of system
failure and hence these may re-occur.
The development of stock market is a complex and multi-faced concept. There are
various indicators of judging stock market development. One common used measure is
the Value Traded Ratio (VR), which is total value of shares traded on a country‟s stock
exchanges as a percent of GDP. The second measure is the value share traded as a
percent of market capitalization. This turnover ratio (TR) measures the trading relative to
the size of the stock market. The third indicator, the market capitalization (MR), which is
market capitalization of listed shares in a stock exchange as a percent of GDP, measures
the size and expansion of the market. The value traded and turnover ratios are considered
as the indicators of liquidity. To measure the stock market development as aggregate
index called SINDEX was constructed. The average of market capitalization ratio (MR),
value traded ratio (VR) and turnover ratio (TR). [i.e.MR+TR+VR/3] has been taken as
the SINDEX in our study.
Moreover, the econometric technique namely Granger causality test has been
followed to identify the existence of cause and effect relationship between FIIs
investment and indicators of stock market development such as trading volume and
market capitalization. As the trading volume and market capitalization are in the form of
time series in our analysis, so there was a need to test the stationarity of these.
Accordingly, we used the Augmented Dickey Fuller (ADF) test to test the stationarity of
trading volume series, market capitalization series and monthly purchase and sales by
foreign institutional investors by using the following equation:
Yt =
1
+
2t+
Yt-1 +
i
m
i=1
Yt-i+ t----------------------------------------(7.1)
The dynamic linkage was examined by using the concept of Granger Causality
Test. The following equations were used for the purpose.
130
n
Yt =
0
+
Xt =
0
+n
i Xt-i
i=1
i=1
i
+n
Yt-i + n
i=1 i
i=1
Yt-i +
i Xt-i
+
1t----------------------------------------(7.2)
2t----------------------------------------(7.3)
In the above equations Yt, Xt are the variables to be tested and
i,
i,
i
i
are
coefficients explaining the relation of dependent variable with the lag terms of
independent variable and lag terms of dependent variable in itself.
1t,
2t
are mutually
uncorrelated white noise errors. t is the time period and i is the number of lags. The null
hypothesis is
i,=
I=
0. If
i
is statistically significant but
I
is not, it means X causes Y.
In the reverse case Y causes X. But if both are significant then causality runs both ways.
We have taken 2 lags as it is prescribed that 2 lags are sufficient to explain
causality. Side by side, we also calculated the compound annual growth rate (CAGR) to
measure the growth pattern of market after the introduction of foreign institutional
investors by using the relative volume technique. Relative volume is calculated as the
average of the market daily trading volume to the total market trading volume over the
period taken into consideration. Here, we used the relative trading volume ratio rather
than market‟s original trading volume data in order to capture the effect of other
developments of the stock market on the trading volume. Moreover, trading volume tends
to grow over time independent of the effect of the trading done by the foreign
institutional investors due to various reasons like increasing awareness and public
confidence in stock market etc. Mathematically, the relative volume is calculated as
follows:
2
= Relative changes in regressand/ Absolute change in the regressor -----------(7.4)
Where
2
is the change in trading volume due to the time, regressand is the
trading volume and regressor is the time, we can say
2
is that part of the trading volume
which grows due to the time. It shows the instantaneous rate of growth. We have
calculated the compound growth rate by taking the antilog of
2 and
subtracting 1 from it
and multiplying the difference by 100. Simultaneously, we have calculated the CAGR of
market capitalization, number of companies listed, P/E ratio, BSE sensex and FII
investments also.
131
7.3 Experiential Consequences
At the outset, let us glance through Table 7.3 which presents month on month
basis trend and progress of trading volume, market capitalization and FIIs net investment
in Indian stock market since the introduction of the foreign institutional investors in
September 1992. Although the doors of the Indian market were opened in the September
1992 for the entry of the FIIs, the actual flows started occurring in January 1993. Hence,
Table 7.3 indicates month wise statistics from January 1993 to August 2007 on various
aspects on foreign institutional investor‟s such as net investment, trading volume and
market capitalization of BSE. It is evident from the table that during the first three years
of their entry, the FIIs participated most actively in India‟s stock market in the month of
January 1994 when their net investments rose as high as Rs. 1233.60 crore, with increase
of 118.22 percent over the previous month. BSE‟s trading volume touched the
psychological barrier of Rs. 10000 crore the first time in December 1993. The similar
behavior was repeated by the market in January 1994 when BSE‟s trading volume rose to
Rs. 10,646 crore. It is disappointing to note that in next two and half year (e.g. till May
1996) trading volume could not reach again the level attained in January 1994. In the
month of June 1996, the trading volume of BSE again crossed the level of Rs. 10,000
crore and rose to Rs. 12,041 crore. In the next very month, it went upto Rs. 14,863 crore.
FIIs net investments, on the other hand, registered more than 300 percent growth merely
in three months period from December 1995 to February 1996. The above mentioned
robust growth phenomenon pertaining to both FII‟s investments and trading volume may
particularly be attributed to the empowerment of SEBI to allow pension funds, mutual
funds, AMCs, banks and institutional portfolio managers established or incorporated
outside the India in November 1995. SEBI proposed to make investments in India on
behalf of broad based funds to apply for FII status.
Another interesting observation from the data given in Table 7.3 belongs to the
pattern of market capitalization of Bombay Stock Exchange. Despite a lot of fluctuations
pertaining to net investments of FIIs, the market capitalization of BSE kept on rising
month by month till September 1995 when it rose to Rs. 530,819 crore. In next four
months it declined around 20 percent. Mention of two important episode of alarming
132
fluctuations is essential here. These are: (a) the East Asian crisis in 1997 and (b) the
Pokran nuclear explosion (May 2008). What is appreciable is the insignificant affect of
these events on the behaviour of the foreign portfolio investors. We might note from
Table 7.3 that net investments of FIIs are observed negative only in three months i.e.
November, December and January during 1997-98, the year of Asian crisis. Similarly, no
significant affect is visible from this table on market capitalization and trading volume of
BSE. During January 1996 to June 1999, the market capitalization of BSE was seen
howering between Rs. 4.3 lakh crore to Rs. 5.95 lakh crore. However, it fluctuated
between Rs. 6.5 lakh crore to 10.3 lakh crore during July 1999 to February 2001. There
after, Indian stock market remained in depression upto April 2003. The stock market
scam of early 2001 in India exerted adverse affect on BSE‟s market capitalization as well
as trading volume for a long time (i.e. March 2001 to November 2001) along with FIIs
inflows to Indian market. After a gap of three years, BSE‟s market capitalization again
touched the level of Rs. 10 lakh crore in October 2003. Despite all odds like black
Monday (May 2004), the market capitalization rose above Rs. 21.24 lakh crore in August
2005.
TABLE 7.3: TREND OF THE TRADING VOLUME, MARKET
CAPITALISATION AND FII INVESTMENTS DURING 1993 TO 2007
BSE
% Change
BSE
FIIs Net
% Change in
Trading
in BSE’s
Market
% Change in
Investments
FIIs
Volume
trading
Capitalization
the BSE’s
Year
(Rs. Cr.)
Investments
(Rs. Cr.)
Volume
(Rs. Cr.)
Capitalization
(1)
(2)
(3)
(4)
(5)
(6)
(7)
Jan. 1993
0.56
-----
1621
-----
-----
-----
Feb. 1993
0.29
-48.21
3652
125.29
-----
-----
Mar.1993
3.42
1079.31
4693
28.50
-----
-----
April. 1993
4.71
37.72
2946
-37.23
175093
-----
May. 1993
41.39
778.77
5434
84.45
180904
3.32
Jun. 1993
95.95
131.82
4541
-16.43
183775
1.59
Jul. 1993
148.54
54.81
3743
-17.57
192080
4.52
Aug. 1993
298.67
101.07
8502
127.14
217291
13.13
133
Sp. 1993
166.76
-44.17
6093
-28.33
223549
2.88
Oct. 1993
195.27
17.10
8612
41.34
220587
-1.32
Nov. 1993
1087.27
456.80
7579
-11.99
266738
20.92
Dec. 1993
565.30
-48.01
10103
33.30
305000
14.34
Jan. 1994
1233.60
118.22
10646
5.37
364139
19.39
Feb. 1994
787.13
-36.19
8251
-22.50
390696
7.29
Mar.1994
820.01
4.18
8086
-2.00
368071
-5.79
April. 1994
525.39
-35.93
3503
-56.68
364868
-0.87
May. 1994
882.00
67.88
3588
2.43
372977
2.22
Jun. 1994
816.37
-7.44
7692
114.38
398044
6.72
Jul. 1994
328.23
-59.79
7940
3.22
408230
2.56
Aug. 1994
424.65
29.38
5965
-24.87
446884
9.47
Sp. 1994
442.94
4.31
8098
35.76
416966
-6.69
Oct. 1994
544.30
22.88
8831
9.05
415381
-0.38
Nov. 1994
61.88
-88.63
5342
-39.51
401692
-3.30
Dec. 1994
26.16
-57.72
7194
34.67
400000
-0.42
Jan. 1995
232.32
788.07
2945
-59.06
352443
-11.89
Feb. 1995
293.10
26.16
3087
4.82
348516
-1.11
Mar.1995
199.26
-32.02
3564
15.45
435481
24.95
April. 1995
186.58
-6.36
2024
-43.21
455315
4.55
May. 1995
203.03
8.82
2348
16.01
456781
0.32
Jun. 1995
360.58
77.60
4280
82.28
462238
1.19
Jul. 1995
647.88
79.68
4836
12.99
465145
0.63
Aug. 1995
548.19
-15.39
4149
-14.21
503630
8.27
Sp. 1995
409.87
-25.23
5019
20.97
530819
5.40
Oct. 1995
320.87
-21.71
4657
-7.21
518623
-2.30
Nov. 1995
191.05
-40.46
3850
-17.33
435107
-16.10
Dec. 1995
412.30
115.81
3817
-0.86
447297
2.80
Jan. 1996
737.98
78.99
4325
13.31
436396
-2.44
Feb. 1996
1613.39
118.62
6746
55.98
499705
14.51
Mar.1996
1089.18
-32.49
4012
-40.53
526476
5.36
April. 1996
1472.59
35.20
7052
75.77
585919
11.29
134
May. 1996
1036.27
-29.63
9156
29.84
518640
-11.48
Jun. 1996
1041.79
0.53
12041
31.51
530815
2.35
Jul. 1996
874.45
-16.06
14863
23.44
501538
-5.52
Aug. 1996
148.38
-83.03
7609
-48.81
497113
-0.88
Sp. 1996
364.66
145.76
6248
-17.89
476805
-4.09
Oct. 1996
365.81
0.32
8869
41.95
455805
-4.40
Nov. 1996
402.64
10.07
6595
-25.64
416750
-8.57
Dec. 1996
422.23
4.87
6556
-0.59
439231
5.39
Jan. 1997
339.74
-19.54
16005
144.13
458261
4.33
Feb. 1997
424.08
24.82
12868
-19.60
484624
5.75
Mar.1997
493.56
16.38
16422
27.62
463915
-4.27
April. 1997
624.74
26.58
12255
-25.37
502082
8.23
May. 1997
889.14
42.32
11439
-6.66
506391
0.86
Jun. 1997
1403.88
57.89
18177
58.90
588496
16.21
Jul. 1997
1002.80
-28.57
21227
16.78
595346
1.16
Aug. 1997
493.66
-50.77
18343
-13.59
550883
-7.47
Sp. 1997
598.59
21.26
18911
3.10
547728
-0.57
Oct. 1997
641.59
7.18
16706
-11.66
526142
-3.94
Nov. 1997
-289.87
-145.18
15326
-8.26
493573
-6.19
Dec. 1997
-182.38
-37.08
18074
17.93
503716
2.06
Jan. 1998
-374.97
105.60
17381
-3.83
469513
-6.79
Feb. 1998
629.05
-267.76
16497
-5.09
526357
12.11
Mar.1998
472.22
-24.93
23310
41.30
560325
6.45
April. 1998
169.17
-64.18
26684
14.47
580238
3.55
May. 1998
-557.45
-429.52
23440
-12.16
561849
-3.17
Jun. 1998
-896.30
60.79
22496
-4.03
485461
-13.60
Jul. 1998
104.68
-111.68
21242
-5.57
483420
-0.42
Aug. 1998
-390.82
-473.35
18211
-14.27
464887
-3.83
Sp. 1998
111.09
-128.42
27647
51.81
479711
3.19
Oct. 1998
-552.46
-597.31
22371
-19.08
452779
-5.61
Nov. 1998
47.37
-108.57
20220
-9.62
446728
-1.34
Dec. 1998
307.46
549.06
26687
31.98
477010
6.78
135
Jan. 1999
370.38
20.46
32516
21.84
502451
5.33
Feb. 1999
354.11
-4.39
31142
-4.23
504233
0.35
Mar.1999
203.67
-42.48
39344
26.34
545361
8.16
April. 1999
814.61
299.97
27003
-31.37
488229
-10.48
May. 1999
1523.52
87.02
36235
34.19
560965
14.90
Jun. 1999
504.27
-66.90
33239
-8.27
584788
4.25
Jul. 1999
1508.49
199.14
46639
40.31
648932
10.97
Aug. 1999
-11.70
-100.78
49997
7.20
710956
9.56
Sp. 1999
-877.84
7402.91
46578
-6.84
704568
-0.90
Oct. 1999
-734.90
-16.28
57699
23.88
673462
-4.41
Nov. 1999
1196.83
-262.86
49121
-14.87
709613
5.37
Dec. 1999
1571.33
31.29
78448
59.70
803353
13.21
Jan. 2000
184.31
-88.27
73164
-6.74
927383
15.44
Feb. 2000
2726.58
1379.34
101842
39.20
1029257
10.99
Mar.2000
1359.63
-50.13
85063
-16.48
912842
-11.31
April. 2000
2438.06
79.32
44601
-47.57
755914
-17.19
May. 2000
172.17
-92.94
57891
29.80
702777
-7.03
Jun. 2000
-985.51
-672.41
86277
49.03
793230
12.87
Jul. 2000
-1569.19
59.23
80346
-6.87
720884
-9.12
Aug. 2000
1626.01
-203.62
92563
15.21
766642
6.35
Sp. 2000
-454.20
-127.93
114432
23.63
692657
-9.65
Oct. 2000
76.32
-116.80
76304
-33.32
653437
-5.66
Nov. 2000
1090.11
1328.34
86971
13.98
699230
7.01
Dec. 2000
-461.78
-142.36
99199
14.06
691162
-1.15
Jan. 2001
3971.58
-960.06
114849
15.78
736631
6.58
Feb. 2001
1574.14
-60.36
101427
-11.69
716173
-2.78
Mar.2001
2204.80
40.06
45170
-55.47
571553
-20.19
April. 2001
1694.76
-23.13
23876
-47.14
567729
-0.67
May. 2001
1030.83
-39.18
31868
33.47
595938
4.97
Jun. 2001
808.64
-21.55
25451
-20.14
553230
-7.17
Jul. 2001
773.45
-4.35
17244
-32.25
531576
-3.91
Aug. 2001
270.00
-65.09
17444
1.16
523036
-1.61
136
Sp. 2001
-228.91
-184.78
21593
23.78
456263
-12.77
Oct. 2001
604.98
-364.29
21922
1.52
481851
5.61
Nov. 2001
161.64
-73.28
24402
11.31
535724
11.18
Dec. 2001
278.54
72.32
30033
23.08
532328
-0.63
Jan. 2002
370.47
33.00
39169
30.42
544397
2.27
Feb. 2002
2024.04
446.34
28572
-27.05
596716
9.61
Mar.2002
484.23
-76.08
25719
-9.99
612224
2.60
April. 2002
-82.11
-116.96
28875
12.27
625587
2.18
May. 2002
-153.89
87.42
28138
-2.55
605065
-3.28
Jun. 2002
-182.90
18.85
23320
-17.12
637753
5.40
Jul. 2002
305.19
-266.86
26724
14.60
584042
-8.42
Aug. 2002
192.29
-36.99
23780
-11.02
605303
3.64
Sp. 2002
421.67
119.29
24410
2.65
570273
-5.79
Oct. 2002
-443.53
-205.18
27641
13.24
563750
-1.14
Nov. 2002
342.34
-177.19
25981
-6.01
601289
6.66
Dec. 2002
457.12
33.53
30582
17.71
628197
4.48
Jan. 2003
1087.63
137.93
30898
1.03
611472
-2.66
Feb. 2003
432.55
-60.23
23461
-24.07
619873
1.37
Mar.2003
292.54
-32.37
20265
-13.62
572198
-7.69
April. 2003
572.38
95.66
20823
2.75
572526
0.06
May. 2003
1232.95
115.41
22510
8.10
660982
15.45
Jun. 2003
2592.95
110.30
24933
10.76
734389
11.11
Jul. 2003
2495.89
-3.74
32976
32.26
775996
5.67
Aug. 2003
2058.07
-17.54
36334
10.18
905193
16.65
Sp. 2003
4047.69
96.67
44698
23.02
933087
3.08
Oct. 2003
6939.72
71.45
52631
17.75
1000494
7.22
Nov. 2003
3282.39
-52.70
45029
-14.44
1065853
6.53
Dec. 2003
6290.59
91.65
54816
21.73
1273361
19.47
Jan. 2004
2492.86
-60.37
65620
19.71
1206854
-5.22
Feb. 2004
3182.74
27.67
51464
-21.57
1196221
-0.88
Mar.2004
8811.80
176.86
50786
-1.32
1201207
0.42
April. 2004
4207.86
-52.25
44864
-11.66
1255347
4.51
137
May. 2004
-3151.29
-174.89
45938
2.39
1023129
-18.50
Jun. 2004
511.00
-116.22
36990
-19.48
1047258
2.36
Jul. 2004
1292.83
153.00
39449
6.65
1135589
8.43
Aug. 2004
2850.25
120.47
38195
-3.18
1216755
7.15
Sp. 2004
2815.61
-1.22
39603
3.69
1309318
7.61
Oct. 2004
3952.04
40.36
34608
-12.61
1337191
2.13
Nov. 2004
6344.57
60.54
35742
3.28
1539595
15.14
Dec. 2004
5890.00
-7.16
50226
40.52
1685989
9.51
Jan. 2005
1324.24
-77.52
43888
-12.62
1661532
-1.45
Feb. 2005
7493.76
465.89
49686
13.21
1730941
4.18
Mar.2005
7885.58
5.23
59528
19.81
1698428
-1.88
April. 2005
-946.29
-112.00
37809
-36.49
1635766
-3.69
May. 2005
-586.82
-37.99
43359
14.68
1783221
9.01
Jun. 2005
5699.40
-1071.23
58479
34.87
1850377
3.77
Jul. 2005
7390.55
29.67
61899
5.85
1987170
7.39
Aug. 2005
4084.87
-44.73
75933
22.67
2123901
6.88
Sp. 2005
3258.00
-20.24
81291
7.06
2254378
6.14
Oct. 2005
-3808.31
-216.89
59102
-27.30
2065612
-8.37
Nov. 2005
4559.07
-219.71
52694
-10.84
2323065
12.46
Dec. 2005
9615.32
110.91
77356
46.80
2489386
7.16
Jan. 2006
5177.18
-46.16
79316
2.53
2616194
5.09
Feb. 2006
7859.26
51.81
70070
-11.66
2695543
3.03
Mar.2006
6347.74
-19.23
118765
69.49
3022191
12.12
April. 2006
722.07
-88.62
87487
-26.34
3255565
7.72
May. 2006
-8930.32
-1336.77
95820
9.52
2842049
-12.70
Jun. 2006
1781.87
-119.95
72013
-24.85
2721677
-4.24
Jul. 2006
1073.16
-39.77
54698
-24.04
2712143
-0.35
Aug. 2006
4643.10
332.66
63084
15.33
2993780
10.38
Sp. 2006
5424.70
16.83
71629
13.55
3185680
6.41
Oct. 2006
8013.10
47.72
69627
-2.79
3370676
5.81
Nov. 2006
9380.10
17.06
101840
46.27
3577308
6.13
Dec. 2006
-3667.40
-139.10
85512
-16.03
3624357
1.32
138
Jan. 2007
3184.86
-186.84
87605
2.45
3779742
4.29
Feb. 2007
4279.07
34.36
88844
1.41
3489214
-7.69
Mar.2007
2057.05
-51.93
78028
-12.17
3545041
1.60
April. 2007
4752.88
131.05
78693
0.85
3828337
7.99
May. 2007
3242.17
-31.79
98821
25.58
4074552
6.43
Jun. 2007
7210.02
122.38
95268
-3.60
4168272
2.30
Jul. 2007
19515.29
170.67
125054
31.27
4529772
8.67
Aug. 2007
-7162.10
-136.70
106042
-15.20
4538005
0.18
Mean
1466.567
-----
36705.37
-----
1029085
-----
Std Devaition
2812.720
-----
30806.28
-----
989214.5
-----
Skweness
2.0613
-----
0.9193
-----
1.9272
-----
Kurtosis
13.3661
-----
2.8777
-----
5.7567
-----
Jarque – Bera
907.4642
-----
24.9031
-----
161.8774
-----
0.0000
-----
0.000004
-----
0.0000
-----
Prob.
Most striking feature of Indian stock market is its all around growth which started taking
place in April 2003 with the improvement in corporate and economic fundamentals. This
growth continued upto August 2007 except a set back on May 2004 (Black Monday).
Both trading volume and market capitalization of BSE registered approximately five
times increase in the aforesaid period of four years and four months. The net investments
by FIIs rose to Rs. 6939.72 crore in October 2003 which touched next height of Rs. 8810
crore in March 2004. However, in May 2006, the net investments observed a negative.
sign with a decline of 1336.67 percent over the previous month. Probably, the above
might have occurred in the midst of some bad news about poor performance of American
economy. The BSE Sensex declined sharply which created a panic buying and selling
activities by the investors. This gave a big blow to Indian stock market. The summary
measures given in the end of the Table 7.3 indicates an average montly trading volume of
Rs. 36705.37 crore and market capitalization of Rs. 1029085 crore during the study
period. Each series is found positively skewed. While the distribution of trading volume
is mesokurtic, it is leptokurtic in case of market capitalization. Figures 7.1 and 7.2 also
indicate that BSE trading volume and FIIs investments are moving in tandem
139
FIGURE 7.1: GROWTH OF BSE TRADING VOLUME OF BSE
FROM 1993 TO 2007
FIGURE 7.2: GROWTH IN FIIs INVESTMENT IN INDIA
FROM 1993 TO 2007
After analyzing month on month data regarding important indicators of stock
market development since the arrival of FIIs, we have summarized the same data by
transforming that into yearly statistics (Table 7.4). It is obvious from the table that the
140
TABLE 7.4: INDICATORS OF INDIAN STOCK MARKET DEELOPMENT AND
GROWTH
Year
Gross
Annual
Turnover
(Rs.
Crore)
71777
No. of
Listed
Companies
FII Net
Investment
in India
(Rs. Crore)
1991-92
Market
Capitalization
(Monthly
Average in
Rs. Crore)
221854
P/E
Ratio
N.A.
BSE
Sensex
(Average
of Daily
Closing)
1880
N.A.
1992-93
245236
45696
2861
13
2896
29.3
1993-94
257327
84536
3858
5,126
2899
46.8
1994-95
396790
67749
4702
4,796
3975
30.4
1995-96
478128
50063
5603
6,942
3289
17.3
1996-97
485785
124284
5832
8,575
3469
14.6
1997-98
530879
207644
5853
5,958
3813
15.2
1998-99
498677
311999
5849
-1,584
3295
14.6
1999-00
729529
685028
5815
10,121
4659
22.7
2000-01
708358
1000032
5869
9,935
4270
19.7
2001-02
544251
307292
5782
8,755
3332
16.33
2002-03
602067
314073
5650
2,690
3206
14.26
2003-04
960514
502620
5528
45,765
4492
14.92
2004-05
1386756
518717
4730
46,215
5741
15.61
2005-06
2237234
816073
4763
41,466
8279
20.92
2006-07
3258103
956185
4796
26,886
12277
20.33
2007-08*
4227788
503878
N.A.
56,427
14400
20.11
181820
42731.3
4361.61
2570.55
2142.27
31.5866
Growth Rate
15.66
22.35
1.71
16.64
7.74
-5.02
R-Square
0.858
0.782
0.142
.497
0.649
0.376
14
14
13
14
14
14
F-value
84.92
50.26
2.14
13.82
25.87
8.43
Significance
0.0000
0.0000
0.1670
.002
0.0000
0.0120
Constant
D.F.
44.3
Sources: Complied from SEBI Annual Report and Hand Book of Statistics and Security Market
in India: A Review 2007 (published by NSE)
*Data is upto August 2007.
141
market capitalization and market turnover have been increasing at a compound annual
growth rate of 15.66 percent and 22.35 percent respectively. Similarly, CAGR of FIIs net
investments and BSE Sensex are 16.64 and 7.74 percent respectively. Hence, the liquidity
has improved in the equity market because of the presence of FIIs. However, the average
P/E ratio has declined at an annual rate of 5.02 percent. The number of listed companies
indicated only 1.71 percent CAGR for the study period. From the above, it can be
concluded that Indian stock market has grown phenomenally with the presence of FIIs
Table 7.5 also indicates that the policy changes effected to stock markets in the
form of permission to FIIs seems to have affected indicators of liquidity. On an average,
the market capitalization ratio (MR) varies from 0.32 to 0.57 during 1991-92 to 2000-01.
But, MR declined to 0.28 and 0.29 in 2001-02 and 2002-03, respectively. The picture of
recent four years i.e. from 2003-04 to 2006-07 is beautiful as the MR has climbed to as
high as 0.87 in 2006-07 from 0.29 in 2002-03. In contrast to MR, the turnover ratio (TR)
slipped to as low as 0.10 in 1996-96 from 0.32 in 1991-92. However, from 1995-96 to
2000-01 this ratio kept on touching new mile stone every year and rose to 1.41 in 200001. But, TR registered a down-ward trend in 2001-02 which continues till date. So far
value traded ratio (VR) is concerned, it rose appreciably with the beginning of reforms in
security market in 1996-97. The ratio was seen the highest in year 2000-01. This ratio has
fluctuated in a narrow space during the last five years. Interestingly, SINDEX the
combined indicator of market development used initially by Demirgue-Kunt and Kevine
(1996) shows a constant improvement in the ratio from 1992-93 to 2001-02. But, VR
declined considerably in 2002-03 and 2003-04. As a result of India shining story, the
ratio has increased upward in the recent years. Thus, the trading volume as a share of
national output is negligible in Indian context. After 1997-98, although turnover, i.e.
indicators of liquidity, has improved to a great extent, yet the ratio is not satisfactory. The
number of shares being traded at stock markets in India is however not appreciable. The
similar results have been drawn by Biwas (2005).
Another aim of this study was to determine causal relationship between FIIs
investments, trading volume, and market capitalization. As stated previously, Granger
causality analysis is used for the purpose. Keeping in view the requirement of this model,
142
TABLE 7.5: GROWTH AND LIQUIDITY ON INDIAN STOCK MARKETS
Year
Value Traded
Market
Turnover
Ratio (VR)1
Capitalization
Ratio (TR) 3
SINDEX4
Ratio (MR) 2
1991-92
0.10
0.32
0.32
0.25
1992-93
0.07
0.35
0.19
0.20
1993-94
0.11
0.35
0.33
0.26
1994-95
0.09
0.51
0.17
0.26
1995-96
0.06
0.57
0.10
0.24
1996-97
0.14
0.54
0.26
0.31
1997-98
0.21
0.55
0.39
0.38
1998-99
0.31
0.49
0.63
0.47
1999-00
0.38
0.41
0.94
0.58
2000-01
0.54
0.38
1.41
0.78
2001-02
0.16
0.28
0.56
0.33
2002-03
0.15
0.29
0.52
0.32
2003-04
0.23
0.43
0.52
0.39
2004-05
0.22
0.58
0.37
0.39
2005-06
0.31
0.86
0.36
0.51
2006-07
0.26
0.87
0.29
0.47
2007-08*
N.A.
N.A.
0.12
N.A.
Sources: Calculated from Handbook of Statistics
Notes 1: Value Traded Ratio is estimated by dividing the total traded value by the GDP
2: Market capitalization ratio is calculated by dividing market capitalization by the GDP
3: Turnover ratio is value of total shares traded divided by market capitalization
4: SINDEX: MR + VR + TR /3
the property of time series data such as stationarity was examined at the out set. The
Augmented Dickey Fuller Unit Root test was applied to check whether the time series of
variables such as trading volume, market capitalization and FII‟s investments are
stationary. The results of it are given in Table 7.6.
It is evident from the table that times series of each variable except the FIIs net
investments and Market Capitalization are stationary at first difference. FIIs net
143
investments and Market Capitalization, both series are stationary at level. In order to
make the data appropriate for the analysis, first we made all the series stationary at level
by using the differencing technique.
TABLE 7.6: RESULTS OF ADF UNIT ROOT TEST
Variable
FIIs Net Investment
FIIs Purchase
FIIs Sale
Trading Volume
Market Capitalization
Value at Level
Value at First Difference
-3.438230
-9.711398
(.0007)
(.0000)
-.234198
-5.750661
(.8154)
(.0000)
-.509205
-5.75425
(.6119)
(.0000)
-1.339320
-8.601633
(.1823)
(.0000)
3.991804
7.12758
(.0001)
(.0000)
Table 7.7 presents the outcome of pair wise Granger causality test. The null
hypothesis that „trading volume does not cause net investment by FIIs‟ is rejected at 5
percent level of significance. It implies that the net investment by foreign institutional
TABLE 7.7: PAIR WISE GRANGER CAUSALITY TEST BETWEEN TRADING
VOLUME, MARKET CAPITALISATION, FIIN, FIIP AND FIIS
Null Hypothesis:
F-Statistic
Probability
Trading Volume does not Granger Cause FIIN*
5.77915
0.00374
FIIN does not Granger Cause Trading Volume
2.44524
0.08979
FIIN does not Granger Cause Market Capitalization*
4.63102
0.01103
Market Capitalization does not Granger Cause FIIN
1.28955
0.27812
Trading Volume does not Granger Cause FIIP*
5.24440
0.00707
FIIP does not Granger Cause Trading Volume
0.79568
0.45453
144
FIIP does not Granger Cause Market Capitalization *
3.44603
0.03662
Market Capitalization does not Granger Cause FIIP*
18.1583
.0000003
FIIS does not Granger Cause Trading Volume
1.19035
0.30902
Trading Volume does not Granger Cause FIIS
0.07669
0.92624
FIIS does not Granger Cause Market Capitalization *
4.84791
0.01026
Market Capitalization does not Granger Cause FIIS*
45.0770
.00069
Rejected at 5 percent level of significance
investors are influenced by the trading volume of BSE. However, the vice-versa is not
true. That is, the FIIs net investments do not exert significant affect on trading volume of
Indian stock market. In contrast, the findings of study by Tripathi (2007), the another
hypothesis „FIIN does not cause market capitalization‟ is rejected and hence the market
capitalization is dependent on foreign investor‟s net investments, significantly.
Surprisingly, the other side of the assumption is found valid and accepted. So, FIIN is not
affected by market capitalization
The third hypothesis „trading volume at BSE does not Granger cause total
purchases by FIIs‟, is also rejected. Hence, purchase of securities at BSE is caused by
trading volume of this market. The opposite of the above said hypothesis gets accepted at
5 percent level of significance. It means trading volume is not dependent on foreign
institutional investments. The table under study further shows that market capitalization
is influenced by purchases of FIIs at BSE. The similar is true with respect to the
hypothesis „market capitalization does not Granger cause FIIP‟. An another important
revelation of the Table 7.7 is that neither sale by FIIs affects trading volume nor trading
volume affects sales. However, sale by FIIs and market capitalization both have turned as
significant determinants of each other.
145
7.4 References:
Biswas, Jaideep (2005), “Foreign Portfolio Investments (FPIs) and Stock Market
Behaviour in A Liberalized Economy: An Indian Experience”, The Asian
Economic Review, August, Vol. 47, No.2.
Demirgue-Kunt, Asli and Ross Levine (1996), “Stock Market Development and
Financial Intermediation; Stylished Facts”, TWBER, May, Vol. 10 No.2.
Dept. of Economic Affairs (2005), Report of the Expert Group on Encouraging
FII Flows and Checking the Vulnerability of Capital Market to Speculative Flows,
Ministry of Finance, Government of India, New Delhi, November.
Dickey, D.A. and W.A. Fuller (1979), “Distribution of the Estimation for
Autoregressive Time series with a Unit Root”, Journal of American Statistical
Association , Vol.79, pp.355-367.
Granger, C.W.J. (1969), “Investigating Causal Relations by Econometric Models
and Cross-Spectral Methods”, Econometrica, Vol.37, pp. 428-438.
Lalitha, S. (1992), “Failure to Woo Funds Forced Move on FIIs”, Observer of
Business and Politics, September, 16.
Tripathi, N. P. (2007), “ Dynamic Relationship between Stock Market, Market
Capitalization and Net FII Investment in India”, ICFAI Journal of Applied
Finance, August, pp. 60-68

146