Fiis' India Investment: Why The Country Is Attractive

Foreign Institutional Investors (FIIs) are a crucial source of foreign capital for India, a country with one of the fastest-growing economies in the world. FIIs, which can include pension funds, investment banks, hedge funds, and mutual funds, are attracted to India's high-growth economy and attractive individual corporations. FIIs have been consistently investing in India since 1992, with a massive US$60.31 billion poured into Indian equities between March 2009 and November 2010, and US$38 billion during the Covid crisis. India has a strong start-up ecosystem, and its markets have provided good returns compared to other emerging markets. The country has also taken several initiatives to attract more foreign capital, making it an even more appealing destination for FIIs.

India's high-growth economy and attractive individual corporations

India's economy is one of the fastest-growing in the world, making it a leading country in attracting foreign investments. The country's equity market offers several investment opportunities for local and foreign institutional investors (FIIs).

Since its inception in 1992, India's FII investments have been largely positive. From March 2009 to November 2010, FIIs invested a massive US$60.31 billion into Indian equities, lifting the Nifty from around 2,500 to 6,300. During the Covid crisis, when the Nifty recovered and surged from around 8,000 (April 2020) to 18,600 (October 2021), Indian markets saw investments of US$38 billion by FIIs.

FIIs can include pension funds, investment banks, hedge funds, and mutual funds. They are important sources of capital in developing economies, and India, as a fast-emerging economy, provides investors with higher growth potential than mature economies.

All FIIs in India must register with the Securities and Exchange Board of India (SEBI) to participate in the market. FIIs are allowed to invest in India's primary and secondary capital markets only through the country's portfolio investment scheme (PIS). This scheme allows FIIs to purchase shares and debentures of Indian companies on the nation's public exchanges.

There are, however, regulations in place. FIIs are generally limited to a maximum investment of 24% of the paid-up capital of the Indian company receiving the investment. The ceiling on FIIs' investments in Indian public-sector banks is only 20% of the banks' paid-up capital. The Reserve Bank of India monitors compliance with these limits daily by implementing cut-off points 2% below the maximum investment.

The Indian rupee is performing better than other major global currencies such as the British pound, Japanese yen, and euro. The government has also liberalized regulations for foreign capital, further strengthening India's position in the global markets.

India has also taken several initiatives to attract more foreign capital to the country, making it an attractive destination for investments. For example, India-focused offshore funds have generated more returns compared to other funds in emerging markets, attracting foreign investors to the country.

The favourable market conditions and the accommodating regulatory environment have allowed Indian asset managers to work more actively with foreign firms and pension funds registered as FIIs in India.

The Reserve Bank of India's monitoring of FII investment

Foreign Institutional Investors (FIIs) are a common feature of developing economies like India's, which offers high growth potential and attractive individual corporations for investment. The Reserve Bank of India (RBI) is tasked with monitoring FII investment in Indian companies on a daily basis.

The RBI has implemented cut-off points that are two percentage points lower than the actual ceilings for FII investment. For example, if the ceiling for FII investment in a company is 24%, the cut-off point will be fixed at 22%. Once the FII investment reaches this cut-off point, the RBI cautions designated bank branches not to purchase any more equity shares of the respective company on behalf of FIIs without prior approval.

The link offices then inform the RBI about the total number and value of equity shares/convertible debentures they propose to buy on behalf of FIIs. The RBI gives clearances on a first-come, first-served basis until investments in companies reach the sectoral caps/statutory ceilings. Once the aggregate ceiling limit is reached, the RBI advises all designated bank branches to stop purchases on behalf of their FII clients and informs the general public through a press release.

The RBI also monitors investment made by non-resident Indians (NRIs) and Persons of Indian Origin (PIOs). The overall investment ceiling for NRIs/PIOs is 10% of the paid-up capital of the Indian company, and this can be raised to 24% with the approval of the company's board. The RBI's monitoring system for NRI investment will continue even after the new monitoring system for foreign investment limits is implemented.

The role of sub-accounts in allowing smaller-scale investment

Foreign Institutional Investors (FIIs) are investors or investment funds that invest in a country outside of their own. The term is most commonly used in India, where FIIs are allowed to invest in the country's financial markets, specifically the primary and secondary capital markets.

In India, FIIs are subject to regulations and limits on their investments. They must register with the Securities and Exchange Board of India (SEBI) and can only invest through the country's portfolio investment scheme (PIS). This scheme allows FIIs to purchase shares and debentures of Indian companies on public exchanges, with a maximum investment of 24% of the paid-up capital of the Indian company.

To facilitate investment in India, a pension fund incorporated outside India can register as an FII or a sub-account of an FII under the SEBI (Foreign Institutional Investors) Regulations, 1995. A sub-account is a segregated account nested under a larger account. In the context of FIIs in India, a sub-account allows investors to participate in the Indian securities market on a smaller scale and without undergoing the same regulatory scrutiny as a fully registered FII.

According to Akil Hirani, managing partner of Majmudar & Co,

> "An FII sub-account is a vehicle available to investors that want to participate in the Indian securities markets on a smaller scale and who do not want to undergo the regulatory scrutiny as an FII. To register a pension fund as its sub-account, an FII has to make an application to the SEBI along with a registration fee of US$1,000 (€780). The sub-account and the FII also have to furnish a joint undertaking. After considering the eligibility requirements for a sub-account under the FII Regulations, which are similar to those applicable to an FII, the SEBI may register the pension fund as a sub-account. A sub-account holder can avail of all the tax and other benefits available to FIIs."

By registering as a sub-account, foreign investors can access the Indian market and benefit from the expertise of local asset managers, while also enjoying the tax and regulatory advantages offered to FIIs. This allows for smaller-scale investment in India without the need for full regulatory compliance, making it a more accessible route for foreign investors.

In summary, sub-accounts play a crucial role in allowing smaller-scale investments by foreign entities in India. They provide a pathway for foreign investors to enter the Indian market, particularly pension funds, by reducing regulatory hurdles and offering tax benefits. This facilitates investment and promotes economic growth, while also ensuring that foreign investors comply with the necessary rules and restrictions imposed by the Indian government.

The impact of FII investment on the Indian rupee

Foreign Institutional Investors (FIIs) have been a significant driver of India's stock market for many years. FIIs are allowed to invest in India's primary and secondary capital markets through the country's portfolio investment scheme (PIS). The impact of FII investment on the Indian rupee is complex and multifaceted. Here are some key points to consider:

Impact on Currency Value

FII outflows can lead to currency depreciation. When FIIs sell Indian stocks, they need to convert their rupee holdings back into foreign currency, typically US dollars. This increased demand for foreign currency can lead to a depreciation of the Indian rupee against other major currencies. A weaker rupee makes imports more expensive and can contribute to inflationary pressures in the economy.

Market Volatility and Sentiment

FIIs account for a substantial portion of trading volume in Indian markets. Therefore, their buying or selling activities can significantly impact market volatility. A large FII outflow can result in sharp declines in stock prices and unpredictable market swings, creating a sense of uncertainty among investors. On the other hand, FII inflows can boost market sentiment and drive stock prices upward.

Liquidity and Investment Opportunities

FII outflows can reduce liquidity in the stock market, making it more difficult for investors to buy or sell large quantities of shares without significantly impacting the price. This reduced liquidity can further cool market sentiment, especially if domestic investors anticipate continued outflows. However, FII selling can also create attractive buying opportunities for long-term domestic investors, as high-quality stocks become available at discounted prices.

Regulatory Considerations

The Reserve Bank of India (RBI) closely monitors FII investment activities to ensure compliance with regulations. The RBI has set investment limits for FIIs, typically capping their investment in an Indian company at 24% of the paid-up capital. The RBI actively tracks these limits and cautions designated bank branches when investment thresholds are reached. This regulatory oversight aims to maintain financial stability and prevent excessive foreign influence in Indian companies.

In summary, FII investment has a significant impact on the Indian rupee and the overall Indian economy. FII inflows can boost the value of the rupee and stimulate the stock market, while outflows can lead to currency depreciation, market volatility, and reduced liquidity. The regulatory environment plays a crucial role in managing the impact of FII investment, ensuring that India's financial markets remain stable and resilient.

The resilience of the Indian equity market in the face of FII selling

Foreign Institutional Investors (FIIs) have been a significant driver of India's stock market for many years. However, in recent times, there has been a notable trend of FII outflows from the Indian market, raising concerns about the impact on Indian equities. Despite this, the Indian equity market has demonstrated resilience in the face of FII selling.

In October 2024, FIIs sold a record-high amount of Indian equity, with net sales reaching Rs 114,445.89 crore. This led to concerns about the potential impact on the Indian stock market, including increased volatility and downward pressure on stock prices. However, the impact has been less severe than expected, thanks to buying support from Domestic Institutional Investors (DIIs).

The resilience of the Indian equity market can be attributed to several factors. Firstly, India's long-term growth story remains compelling, even amid short-term headwinds such as rising inflation and global economic uncertainty. India's increasing weight in global indices has made it a more attractive investment destination compared to China, which faces structural challenges and geopolitical risks. This shift in global investor sentiment has resulted in an increasing allocation of funds to Indian equities.

Secondly, the regulatory environment in India provides a clear and defined route for foreign investors to access the Indian capital markets. FIIs can register with the Securities and Exchange Board of India (SEBI) and invest through the portfolio investment scheme (PIS), which allows them to purchase shares and debentures of Indian companies on public exchanges. The Reserve Bank of India also actively monitors compliance with investment limits, helping to maintain stability and prevent excessive influence by FIIs.

Additionally, the availability of high-quality asset managers and sub-advisers in India has made it easier for foreign institutions to invest in the country. These asset managers provide guidance to FIIs on various investment options, including private equity and real estate.

While the short-term outlook for the Indian market remains uncertain, the country's strong fundamentals and robust domestic demand continue to support its long-term growth trajectory. The resilience of the Indian equity market in the face of FII selling highlights the market's ability to withstand temporary setbacks and maintain its appeal to both foreign and domestic investors.

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