FIIs Flows in India: The Role of Macro Level Variables

The role of foreign investment in promoting economic growth has received considerable attention in India since independence. An important feature of the development of Indian stock market in the last twenty years has been the growing participants of foreign investors. The increases in foreign investments bring global liquidity into capital markets and raise the price earnings ratios, thereby reducing the cost of capital. It has also brought both quantitative and qualitative developments in the domestic stock market such as expansion of securities business, increased depth and breadth of the market and efficient stock pricing. Moreover these flows are often accompanied by a transfer of expertise, technology and other institutional benefits. Though numerous research studies have been conducted in respect of FIIs into India, most of them have been restricted to assess the impact of such flows on stock markets. Very few studies have focused on the aggregate impact of FIIs inflow over various areas of financial market e.g. capital market, foreign exchange market, money market as well as other macro-economic variables such as inflation, money supply, index of industrial production (IIP). Given this background the present study assesses the causes and effects of FIIs net flows on all segments of the Indian economy viz. capital market, foreign exchange market, money market and other macro-economic variables such as index of industrial production (IIP as a proxy of GDP), inflation, money supply and foreign exchange reserves so as to enable policy makers to take informed decision in this regard. In this study, we predominantly examined the macro level determinants of FIIs flows into India with the support of empirical data for the period January 1994 to December 2016.

We find that there is a bi-directional causality between Net FIIs flows and the BSE Sensex. The FIIs is both ‘driven ’and ‘drives ’the market. In addition, FIIs flows leads to accumulation in the foreign exchange reserves thereby improving India's international creditworthiness.

The analysis provides the evidence of bi-directional causality running from Net FIIs flows to IIP. This shows that the real economy growth of India both determines and determined by the volume of FIIs flows.

In addition, Net FIIs flows have the potential of influencing the process of economic development of India through the positive impact on foreign exchange reserves. Therefore, the policy makers should provide FIIs with more opportunities and reasons to invest in Indian capital markets by implementing prudential norms. Capital control should not be perceived as a substitute to prudent macroeconomic policies and well regulated financial system. Macro prudential instruments supplemented to the monetary policy may help in checking inflation and ensuring financial stability in the wake of excess global liquidity.