The impact of FII regulations in India a time-series intervention analysis of equity flows

Our results strongly suggest that liberalisation policies have had the desired expansionary effect and have either increased the mean level of FII inflows and/or the sensitivity of these flows to a change in BSE return and/or the inertia of these flows.

In this paper we examine the impact of the FII policy reforms on FII portfolio flows to the Indian stock markets. Given the volatile nature of capital flows to emerging markets seen in the early 1990s, FII investment in India, which began in January 1993, called for special regulatory attention. The promulgation of legislation pertaining to foreign investment in 1995 marked a watershed for FII flows to India, as it led to a significant increase in the level of FII equity inflows. We try to assess the impact on FII flows of several policy revisions related to FII investment during the period January 1999 to January 2004, through a multivariate GARCH regression model. Using techniques of time series intervention analyses we incorporate the effect of each individual policy intervention in a model that includes the two most important covariates of FII flows to India, namely stock market (BSE) returns and past FII flows. The range of policies considered encompasses liberalisation policies as well as restrictive ones taken to assure stability of flows. Our results strongly suggest that liberalisation policies have had the desired expansionary effect and have either increased the mean level of FII inflows and/or the sensitivity of these flows to a change in BSE return and/or the inertia of these flows. On the other hand, interestingly, the restrictive measures aimed at achieving greater control over FII flows also do not show any significant negative impact on the net inflows; we find that these policies mostly render FII investments more sensitive to the domestic market returns and raise the inertia of the FII flows.