Stock market Volatility is one of the most important factors concerned by investors before investing in the stock market. Volatility refers to the degree of price variation during a particular period, the expected return from an investment is determined by the risk associated with the same. Investors interpret an increase in stock market volatility as an increase in the risk of equity investment and consequently they shift their funds to less risky assets. It puts a downward pressure on the stock prices making room for higher expected future returns to compensate for the excess risk. The volatility is one of the crucial inputs in all the investment decisions including portfolio construction, pricing of assets and their derivatives, designing hedging strategies, determining capital adequacy and margin requirements besides other tools of risk management. The flow of information is the main determinant of volatility; more the amount of unexpected information (news) reaching the market, the more volatility it causes in the asset prices. Volatility is also affected by the price discovery mechanism and speed of adjustment of security prices to the news. Gradual adjustment in the prices causes less volatility than the instantaneous adjustment. Also, the macroeconomic variables affect the investor's interests causes price fluctuations in shares leads to volatility in the market
FPI consists of securities and other foreign financial assets held by the foreign investor it doesn't provide direct ownership of financial assets to investors, but are relatively liquid depending on the volatility of the market where the investment takes place in.FPI can be made by individuals, companies, or even governments in international countries, it allows investors to diversify their portfolio with an international advantage. The opening up of the Indian economy in the year 1991, unlocked greater and better opportunities to attract foreign funds in the Indian stock market. RBI’s decision to allow SEBI registered FIIs/NRIs/PIOs/OCBs to invest in the Indian stock market through the portfolio investment scheme was a game-changer. Entities that can register as FIIs include asset management companies, pension funds, mutual funds, banks, investment trusts, nominee companies, incorporated/institutional portfolio. Foreign Portfolio Investors (FPI’s) & Foreign Institutional Investors (FII’s) have been one of the biggest drivers of the Indian stock market. According to data available publicly, Foreign Portfolio Investors (FII’s) & Foreign Institutional Investors (FII’s) have invested over US$ 171.81 billion in India during the period between the years 2002 to 2018. FPI’s & FII’s find India an attractive destination because of the highly developed Indian stock market.
Category I- Government and Government related foreign investors such as central banks, sovereign wealth funds.
Category II-Funds which are broad-based, appropriately regulated, whose investment manager is appropriately regulated Mfs, investment trusts, insurance companies, banks, AMCs, pension funds, portfolio managers, swap dealers, investment managers.
Category III- Endowments, charitable societies, corporate bodies, trusts, family offices and individuals
In the past, foreign portfolio investment has played an important role in determining the overall balance of payments. Foreign portfolio investment enlarges the liquidity of domestic capital markets, and as well as develops market efficiency. As markets become more liquid, a wide variety of investments can be financed. The greatest beneficiaries of this will be start-ups. Another advantage of foreign portfolio investment is that they bring discipline and knowledge into the Indian stock market. In the broader market, investors can reap greater rewards by investing in emerging investment opportunities. As businesses compete for financing, they will face demands for better information as foreign portfolio investors generally ask for a higher level of information disclosure and accounting standards, and bring with them a rich experience. A higher inflow of foreign portfolio investment helps in boosting the Indian stock market. As the market's liquidity and functionality progress, equity prices will increasingly reflect the fundamental values of the firms, enhancing the more efficient allocation of capital flows. Foreign portfolio investors also support the domestic capital markets by introducing more sophisticated technologies for managing portfolios.
Sectors that are mostly focused by FPIs in India-Sector classified as 'other' by NSDL got $1.4 bn investments in 2019 between September and October 15, contributed 7% of the total asset under management of FPIs.Insurance & automobile $643mn & $179 mn respectively, oil and gas stocks attracted 330 cr rupees. There are five sectors accounted for 59.2% of FPIs asset under management-financials, oil & gas, Software & services, Household &personal product, and automobile.
When foreign portfolio investors invest funds in Indian stock market, the price of shares goes up which also push the liquidity in the secondary market in the effect of this cost of issuing shares goes down which enhance the issue of more equity as it increases the local demand as well as foreign demand due to improved access. Thus, it encourages more players and leads to higher efficiency in the market by increasing more supply, demand, and liquidity. Total foreign capital inflow affects the exchange rate, international reserves, monetary policy, saving, and investment behavior of the country.
A well-developed stock market has its impact on demand-side as it provides investors with an array of assets which are of varying degree of risk, return and liquidity this increases the choice of assets and the existence of a vibrant stock market provide savers with more liquidity and options thereby inducing more savings. This all encourages more savings in equity related instruments, raises the domestic savings rate, and improves the capital formation.
Determinants of FPIs which affect the Indian stock market volatility - GDP growth rate, Exchange Rate, Credit rating of securities, Tax rates, Balance of payments, Inflation rates, Stock market index, imports to reserve ratio, etc.
GDP Growth
FPI is eager to invest in a country with a high growth rate linking the interest of higher returns on invested capital. Portfolio investors basically look for short term gains. They invest when the high potential is discovered in-country and sell their proportion at the time of distress. GDP growth is a measure to collate the growth of the country with the hidden potential identified by the investors.
Imports to reserve ratio
This ratio indicates to pay off the debts with reserves. A higher ratio indicates better liquidity in the country which builds the confidence of the investors if they withdraw their funds. It is expected that countries with a sufficient amount of reserve are perceived to be creditworthy and the probability of default is quite less.
Stock Market Index
Domestic stock market returns can influence the FPI in a positive and significant way. Higher stock market returns attract foreign investors and lower stock market returns repel to invest some more profitable destinations.
Exchange rate
The volatility of the exchange rate is expected to have a negative impact on inflows of capital in host countries. A higher volatility means a higher degree of uncertainty in returns earned by foreign investors. The exchange rate is taken as the effectiveness of macroeconomic policies in the host country. Stability in the exchange rate is expected to be observed by foreign investors, especially portfolio investors to earn higher returns.
Inflation rates
Inflation represents one of the major threats to investors. When the inflation rates start to rise, investors get really nervous in expectation of the potentially negative consequences.
Balance of Payments
Government finance is an important issue that is expected to affect portfolio flows. High fiscal deficits imply increasing govt liabilities. More liabilities could lead to the necessity to increase taxes and might in an extreme case lead to eventual default on international debt. Hence, large fiscal deficits increase the country's risk and therefore, hold back potential investment flows. Different indicators such as fiscal balance, Government to GDP and to revenues and govt expenditure to GDP should be good proxies for understanding govt finance
Tax Rates
The nature of a country’s tax laws has an important effect on attracting foreign investors. Investors base their investment decisions on the expected after-tax return on an investment with a perceived level of risk. This is one of the key policy instruments available to developing countries to attract foreign investment.
Credit rating of securities
The credit rating is a financial indicator to potential investors of debt securities such as bonds. These are assigned by credit rating agencies such Standard & Poor’s, Fitch Ratings, and Moody’s. Credit Rating agencies use their judgment and experience in determining what public and private information should be considered in giving a rating to a particular company or govt. The credit rating is used by individuals and entities to determine the likelihood that the government will pay its bond obligations.
(Year-2010, Net FPI Inflows-179674, BSE Sensex-18686.16) , (Year-2011, Net FPI Inflows-39353 , BSE Sensex-17724.38), (Year-2012, Net FPI Inflows-163347.9, BSE Sensex-17830.78), (Year-2013, Net FPI Inflows-62286, BSE Sensex-19727.07), (Year-2014, Net FPI Inflows-256213, BSE Sensex-25343.47), (Year-2015, Net FPI Inflows-63663, BSE Sensex-27371.14), (Year-2016, Net FPI Inflows(-23079), BSE Sensex-26506.64), (Year-2017, Net FPI Inflows-200048, BSE Sensex-31162.84), (Year-2018,Net FPI Inflows(-80919), BSE Sensex-35683.95), (Year-2019, Net FPI Inflows-136835, BSE Sensex-38716.27), (Year-2020, Net FPI Inflows(-130002), BSE Sensex-36163.09)
Source: Data collected from NSDL website
As from the above data, it reveals that the foreign portfolio investors in ten years played a significant role to fluctuating market volatility as the correlation between BSE sensitivity index and net FPI inflows have negative correlation which is -0.38 deduce that when Sensex goes up, FPI weakens means that FPI is selling their investments for profit booking and when Sensex falls, but FPI rises it means Foreign investors are searching for profitable opportunities, one of the reasons for FPI was rising in 2010 because of RBI did repo rate at its lowest level at 5.15%.In 2019, FM Nirmala Sitharaman unveiled Rs 25000 cr AIF to help the distressed real estate sector. There were massive outflows in this year government hike surcharge on FPIs for that FPIs withdrew more than Rs 24500 cr from domestic equities and put pressure on the rupee slumped against US dollar, after removal of enhanced surcharge was a big positive action took by govt did not compromise on spending during 2012-13 slowdown, as it reduced the fiscal deficit by 1% of GDP from 5.9% to 4.9%. On the monetary policy front, RBI slashed cash reserve ratio by 200bps and repo rate by 100bps Fall in FPIs during the year 2016 was uncertainty over the outcome of the US presidential elections, expectations of a rate hike but the US Federal Reserve and the govt’s demonetization drive back home as it created domestic cash crunch and sparked intense selling pressure in the capital markets. In 2017, the reason behind the rapid rise of inflows in the capital market was it regained its status as one of the most favored destinations of FPIs.In 2018, massive outflows by FPIs could be because of RBI repo rate decision, US Fed rate hike, rupee value, inflation, trade deficit, global liquidity and trade disputes, rising crude prices. They withdrew a net amount of Rs 6430 cr. Increase in crude oil leads to an increased current account deficit and high domestic inflation, the rising current account deficit is putting pressure on INR exchange rates and higher domestic inflation will put upward pressure on interest rates make dollar returns weaker for FPIs which leads to withdrawal of funds.
Copyright 2020 Swarnim Goyal
Connect on LinkedIn- https://www.linkedin.com/in/swarnim-goyal-169717180/
FPI consists of securities and other foreign financial assets held by the foreign investor it doesn't provide direct ownership of financial assets to investors, but are relatively liquid depending on the volatility of the market where the investment takes place in.FPI can be made by individuals, companies, or even governments in international countries, it allows investors to diversify their portfolio with an international advantage. The opening up of the Indian economy in the year 1991, unlocked greater and better opportunities to attract foreign funds in the Indian stock market. RBI’s decision to allow SEBI registered FIIs/NRIs/PIOs/OCBs to invest in the Indian stock market through the portfolio investment scheme was a game-changer. Entities that can register as FIIs include asset management companies, pension funds, mutual funds, banks, investment trusts, nominee companies, incorporated/institutional portfolio. Foreign Portfolio Investors (FPI’s) & Foreign Institutional Investors (FII’s) have been one of the biggest drivers of the Indian stock market. According to data available publicly, Foreign Portfolio Investors (FII’s) & Foreign Institutional Investors (FII’s) have invested over US$ 171.81 billion in India during the period between the years 2002 to 2018. FPI’s & FII’s find India an attractive destination because of the highly developed Indian stock market.
FPI is categorized into three categories by SEBI
Category I- Government and Government related foreign investors such as central banks, sovereign wealth funds.
Category II-Funds which are broad-based, appropriately regulated, whose investment manager is appropriately regulated Mfs, investment trusts, insurance companies, banks, AMCs, pension funds, portfolio managers, swap dealers, investment managers.
Category III- Endowments, charitable societies, corporate bodies, trusts, family offices and individuals
In the past, foreign portfolio investment has played an important role in determining the overall balance of payments. Foreign portfolio investment enlarges the liquidity of domestic capital markets, and as well as develops market efficiency. As markets become more liquid, a wide variety of investments can be financed. The greatest beneficiaries of this will be start-ups. Another advantage of foreign portfolio investment is that they bring discipline and knowledge into the Indian stock market. In the broader market, investors can reap greater rewards by investing in emerging investment opportunities. As businesses compete for financing, they will face demands for better information as foreign portfolio investors generally ask for a higher level of information disclosure and accounting standards, and bring with them a rich experience. A higher inflow of foreign portfolio investment helps in boosting the Indian stock market. As the market's liquidity and functionality progress, equity prices will increasingly reflect the fundamental values of the firms, enhancing the more efficient allocation of capital flows. Foreign portfolio investors also support the domestic capital markets by introducing more sophisticated technologies for managing portfolios.
Sectors that are mostly focused by FPIs in India-Sector classified as 'other' by NSDL got $1.4 bn investments in 2019 between September and October 15, contributed 7% of the total asset under management of FPIs.Insurance & automobile $643mn & $179 mn respectively, oil and gas stocks attracted 330 cr rupees. There are five sectors accounted for 59.2% of FPIs asset under management-financials, oil & gas, Software & services, Household &personal product, and automobile.
How FPI affects Indian Secondary market
When foreign portfolio investors invest funds in Indian stock market, the price of shares goes up which also push the liquidity in the secondary market in the effect of this cost of issuing shares goes down which enhance the issue of more equity as it increases the local demand as well as foreign demand due to improved access. Thus, it encourages more players and leads to higher efficiency in the market by increasing more supply, demand, and liquidity. Total foreign capital inflow affects the exchange rate, international reserves, monetary policy, saving, and investment behavior of the country.
A well-developed stock market has its impact on demand-side as it provides investors with an array of assets which are of varying degree of risk, return and liquidity this increases the choice of assets and the existence of a vibrant stock market provide savers with more liquidity and options thereby inducing more savings. This all encourages more savings in equity related instruments, raises the domestic savings rate, and improves the capital formation.
Determinants of FPIs which affect the Indian stock market volatility - GDP growth rate, Exchange Rate, Credit rating of securities, Tax rates, Balance of payments, Inflation rates, Stock market index, imports to reserve ratio, etc.
GDP Growth
FPI is eager to invest in a country with a high growth rate linking the interest of higher returns on invested capital. Portfolio investors basically look for short term gains. They invest when the high potential is discovered in-country and sell their proportion at the time of distress. GDP growth is a measure to collate the growth of the country with the hidden potential identified by the investors.
Imports to reserve ratio
This ratio indicates to pay off the debts with reserves. A higher ratio indicates better liquidity in the country which builds the confidence of the investors if they withdraw their funds. It is expected that countries with a sufficient amount of reserve are perceived to be creditworthy and the probability of default is quite less.
Stock Market Index
Domestic stock market returns can influence the FPI in a positive and significant way. Higher stock market returns attract foreign investors and lower stock market returns repel to invest some more profitable destinations.
Exchange rate
The volatility of the exchange rate is expected to have a negative impact on inflows of capital in host countries. A higher volatility means a higher degree of uncertainty in returns earned by foreign investors. The exchange rate is taken as the effectiveness of macroeconomic policies in the host country. Stability in the exchange rate is expected to be observed by foreign investors, especially portfolio investors to earn higher returns.
Inflation rates
Inflation represents one of the major threats to investors. When the inflation rates start to rise, investors get really nervous in expectation of the potentially negative consequences.
Balance of Payments
Government finance is an important issue that is expected to affect portfolio flows. High fiscal deficits imply increasing govt liabilities. More liabilities could lead to the necessity to increase taxes and might in an extreme case lead to eventual default on international debt. Hence, large fiscal deficits increase the country's risk and therefore, hold back potential investment flows. Different indicators such as fiscal balance, Government to GDP and to revenues and govt expenditure to GDP should be good proxies for understanding govt finance
Tax Rates
The nature of a country’s tax laws has an important effect on attracting foreign investors. Investors base their investment decisions on the expected after-tax return on an investment with a perceived level of risk. This is one of the key policy instruments available to developing countries to attract foreign investment.
Credit rating of securities
The credit rating is a financial indicator to potential investors of debt securities such as bonds. These are assigned by credit rating agencies such Standard & Poor’s, Fitch Ratings, and Moody’s. Credit Rating agencies use their judgment and experience in determining what public and private information should be considered in giving a rating to a particular company or govt. The credit rating is used by individuals and entities to determine the likelihood that the government will pay its bond obligations.
(Year-2010, Net FPI Inflows-179674, BSE Sensex-18686.16) , (Year-2011, Net FPI Inflows-39353 , BSE Sensex-17724.38), (Year-2012, Net FPI Inflows-163347.9, BSE Sensex-17830.78), (Year-2013, Net FPI Inflows-62286, BSE Sensex-19727.07), (Year-2014, Net FPI Inflows-256213, BSE Sensex-25343.47), (Year-2015, Net FPI Inflows-63663, BSE Sensex-27371.14), (Year-2016, Net FPI Inflows(-23079), BSE Sensex-26506.64), (Year-2017, Net FPI Inflows-200048, BSE Sensex-31162.84), (Year-2018,Net FPI Inflows(-80919), BSE Sensex-35683.95), (Year-2019, Net FPI Inflows-136835, BSE Sensex-38716.27), (Year-2020, Net FPI Inflows(-130002), BSE Sensex-36163.09)
Source: Data collected from NSDL website
As from the above data, it reveals that the foreign portfolio investors in ten years played a significant role to fluctuating market volatility as the correlation between BSE sensitivity index and net FPI inflows have negative correlation which is -0.38 deduce that when Sensex goes up, FPI weakens means that FPI is selling their investments for profit booking and when Sensex falls, but FPI rises it means Foreign investors are searching for profitable opportunities, one of the reasons for FPI was rising in 2010 because of RBI did repo rate at its lowest level at 5.15%.In 2019, FM Nirmala Sitharaman unveiled Rs 25000 cr AIF to help the distressed real estate sector. There were massive outflows in this year government hike surcharge on FPIs for that FPIs withdrew more than Rs 24500 cr from domestic equities and put pressure on the rupee slumped against US dollar, after removal of enhanced surcharge was a big positive action took by govt did not compromise on spending during 2012-13 slowdown, as it reduced the fiscal deficit by 1% of GDP from 5.9% to 4.9%. On the monetary policy front, RBI slashed cash reserve ratio by 200bps and repo rate by 100bps Fall in FPIs during the year 2016 was uncertainty over the outcome of the US presidential elections, expectations of a rate hike but the US Federal Reserve and the govt’s demonetization drive back home as it created domestic cash crunch and sparked intense selling pressure in the capital markets. In 2017, the reason behind the rapid rise of inflows in the capital market was it regained its status as one of the most favored destinations of FPIs.In 2018, massive outflows by FPIs could be because of RBI repo rate decision, US Fed rate hike, rupee value, inflation, trade deficit, global liquidity and trade disputes, rising crude prices. They withdrew a net amount of Rs 6430 cr. Increase in crude oil leads to an increased current account deficit and high domestic inflation, the rising current account deficit is putting pressure on INR exchange rates and higher domestic inflation will put upward pressure on interest rates make dollar returns weaker for FPIs which leads to withdrawal of funds.
Copyright 2020 Swarnim Goyal
Connect on LinkedIn- https://www.linkedin.com/in/swarnim-goyal-169717180/
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