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

- 126 -

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

and Others

Total

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

- 127 -

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

- 128 -

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

129

TABLE 7.2: SHARE HOLDING PATTERN AT THE END OF MARCH 2007 IN INDIA

(In percentage)

Category Indian

Promoters

Foreign

Promoter

Banks

/Financial

Inst./Govt

FIIs Mutual

Funds

Venture

Capital

Funds

Others

Institution

Bodies

Corporate Individuals Others

Shares

held by

Custodians

Banks 43.79 1.02 4.76 18.41 3.59 0.59 0.54 8.27 13.27 0.79 4.98

Engineering 24.31 2.80 11.00 11.45 10.24 0.00 0.35 8.44 22.53 7.89 0.99

Finance 37.76 2.43 10.20 18.18 2.06 0.00 3.17 6.70 16.81 2.54 0.13

FMCG 16.27 16.19 13.92 11.91 7.79 0.00 0.00 3.61 14.79 14.64 0.69

IT 40.84 6.00 2.02 14.53 2.82 2.69 0.34 6.19 17.52 3.19 3.86

Infrastructure 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

% to total

Shareholding 48.08 6.87 5.85 10.78 3.23 0.63 0.42 5.60 13.78 2.76 2.01

Source: Indian Security Market – A Review, 2007

130

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.

131

Yt = 0 + n

i=1 i Xt-i + n

i=1 i Yt-i + 1t----------------------------------------(7.2)

Xt = 0 + n

i=1 i Yt-i + n

i=1 i Xt-i + 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.

132

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

133

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

Year

(1)

FIIs Net

Investments

(Rs. Cr.)

(2)

% Change in

FIIs

Investments

(3)

BSE

Trading

Volume

(Rs. Cr.)

(4)

% Change

in BSE’s

trading

Volume

(5)

BSE

Market

Capitalization

(Rs. Cr.)

(6)

% Change in

the BSE’s

Capitalization

(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

134

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

135

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

136

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

137

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

138

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

139

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 -----

Prob. 0.0000 ----- 0.000004 ----- 0.0000 -----

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

140

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

141

TABLE 7.4: INDICATORS OF INDIAN STOCK MARKET DEELOPMENT AND

GROWTH

Year Market

Capitalization

(Monthly

Average in

Rs. Crore)

Gross

Annual

Turnover

(Rs.

Crore)

No. of

Listed

Companies

FII Net

Investment

in India

(Rs. Crore)

BSE

Sensex

(Average

of Daily

Closing)

P/E

Ratio

1991-92 221854 71777 N.A. N.A. 1880 44.3

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

Constant 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

D.F. 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

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.

142

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 2000-

01. 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,

143

TABLE 7.5: GROWTH AND LIQUIDITY ON INDIAN STOCK MARKETS

Year Value Traded

Ratio (VR)1

Market

Capitalization

Ratio (MR) 2

Turnover

Ratio (TR) 3

SINDEX4

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

144

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

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*

FIIN does not Granger Cause Trading Volume

5.77915

2.44524

0.00374

0.08979

FIIN does not Granger Cause Market Capitalization*

Market Capitalization does not Granger Cause FIIN

4.63102

1.28955

0.01103

0.27812

Trading Volume does not Granger Cause FIIP*

FIIP does not Granger Cause Trading Volume

5.24440

0.79568

0.00707

0.45453

Variable Value at Level Value at First Difference

FIIs Net Investment -3.438230

(.0007)

-9.711398

(.0000)

FIIs Purchase -.234198

(.8154)

-5.750661

(.0000)

FIIs Sale -.509205

(.6119)

-5.75425

(.0000)

Trading Volume -1.339320

(.1823)

-8.601633

(.0000)

Market Capitalization 3.991804

(.0001)

7.12758

(.0000)

145

FIIP does not Granger Cause Market Capitalization *

Market Capitalization does not Granger Cause FIIP*

3.44603

18.1583

0.03662

.0000003

FIIS does not Granger Cause Trading Volume

Trading Volume does not Granger Cause FIIS

1.19035

0.07669

0.30902

0.92624

FIIS does not Granger Cause Market Capitalization *

Market Capitalization does not Granger Cause FIIS*

4.84791

45.0770

0.01026

.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.

146

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