The finance minister in his 1992-93 Budget speech had said: We will consider ways of allowing reputable foreign investors, such as pension funds, to invest in our capital markets, with suitable mechanisms to ensure that this does not threaten loss of management control". Subsequently, on September 14, 1992, Sebi in a press note stated that: Foreign institutional investors including institutions such as pension funds, mutual funds, investment trusts, asset management companies, nominee companies and incorporated/institutional portfolio managers would be allowed portfolio investments in primary or secondary markets subject to a ceiling of 24 per cent of the issued share capital for the total holdings of all FIIs in one company, with a sub-limit of 5 per cent on the holding of a single FII".
The 1996-97 Budget raised the sub-limit of 5 per cent to 10 per cent. Besides, FIIs were also allowed to invest in unlisted companies. Sebi also broadened the definition of an FII to include university funds, endowments, foundations and charitable trusts/societies with a track record.
As on August 31, 1996, there were 401 registered FIIs entitled to invest in the Indian securities markets.
Net investment by FIIs in 1992-93 was negligible. In 1993-94 and 1994-95, it was quite substantial at $1,665 million and $1,503 million, respectively. In 1995-96, it rose to $1,892 million and in the first five months of the current year, it was $1,450 million. As on August 31, 1996, the net amount invested was $6.65 billion i.e about Rs 24,000 crore.
Market capitalisation of Indian stock markets as on August 31, 1996 stood at Rs 5,40,340 crore. The net FII investment of about Rs 24,000 crore thus amounted to a meagre 4.4 per cent of the market capitalisation. Prima facie, therefore, it seems that FII operations hardly made any significant impact on the market. A deeper analysis, however, indicates that their operations can, and often, do dictate the market.
The FIIs have invested in about 100 companies, and about 90 per cent of these investments are in about 30 scrips of group 'A' of Bombay Stock Exchange. The market capitalisation of these 30 scrips is about Rs 200,000 crore, but floating stocks come to about Rs 100,000 crore only. The question, therefore, is whether a freely mobile investment of about Rs 24,000 crore in these 30 scrips can dictate the market.
This poser also needs to be considered in the context of other major players in the market. Common investors have become quite uncommon today because of the severe beatings that they have received since April 1992, when the Sensex peaked 4467. The losses incurred by them have virtually forced them out of the market. Today, they are mainly sellers driven by liquidity considerations and are rarely buyers induced by investment considerations.
The Unit Trust of India, which once dominated the market, is no more a major operator as it too has been hit by liquidity considerations. Speculators have ceased to be a force as the revised carry-over system at the BSE is too cumbersome for ventilation of proper speculative dealings. Trading on account in a settlement cycle done at the National Stock Exchange (NSE) and other stock exchanges in the country, although on a large scale, particularly at the former, cannot be considered to be a force as all these operations are effected with a view to pocketing differences mostly on the same day or at best by the end of the trading cycle.
The stock markets seem to have surrendered to the whims and fancies of the FIIs. Although the number of registered FIIs is over 400, the actual number of active operators comes to about a dozen. It is, therefore, easy for them to act in concert and influence the course of prices. Moreover, they have certain distinct advantages over domestic operators. The long-term tax payable by them is a meagre 10 per cent against 20 per cent for residents. The short-term capital gains tax for them has also been lowered to 30 per cent with effect from April 1, 1993 while domestic operators have to pay at the rate of 40 per cent for individuals and 43 per cent for companies.
Even these reduced rates for FIIs are mainly on paper, as most of them pay virtually no tax as they are registered in Mauritius. They also have the advantage of arbitraging between the domestic market and the GDR market abroad. In fact, FIIs are reportedly using this position to manipulate prices, particularly at the time of pricing of GDRs by selling the stock in the domestic market thereby attempting to beat down the price and picking up the same from the GDR route later at a cheaper price. The fall in prices of the shares of State Bank of India from Rs 285 to Rs 250 in August-September 1996 prior to the launching of its $400 million GDRs has been attributed primarily to such attempts by the FIIs.
A BSE study has established a clear correlation between FII investments and the Sensex "" it moves up sharply when FII investments are heavy and declines sharply with sales by FIIs.
The stock markets have become volatile in the '90s. The average annual range of fluctuations of the all-India index number of ordinary shares compiled by the RBI was only 25.0 per cent during the '80s which was on par with the corresponding index numbers of 23.8 per cent of London Stock Exchange and 25.2 per cent of New York Stock Exchange, and well below the global average of 31.2 per cent of 15 leading stock markets of the world. The first six years of the current decade "" from 1990 to 1995 "" have proved to be very volatile with the RBI index averaging around 47 per cent against the global average of below 30 per cent. FII operators, sharp as they are, have accelerated the volatility of the market thereby distracting ordinary investors.
A higher ceiling on FII investment will not only increase their dominance over the stock markets but also aggravate market volatility. It can also lead to a situation where FIIs can collectively block the adoption of special resolutions by companies. Even markets like South Korea and Taiwan, which had opened much before India did, had limited foreign portfolio investment to only 15 per cent of the issued capital of listed companies. Indian stock markets need to mature further before any further relaxation for portfolio investment by FIIs is considered. What needs to be concentrated upon is foreign direct investment, which is at a dismal annual low level of $2 billion against over $30 billion in China.
This is despite the fact that India has several advantages over the latter in terms of an established legal system, transparency in operations, a burgeoning upper middle class market, a large pool of labour including technical expertise available at low rates, etc. What is lacking, however, is proper marketing. Let us, therefore, concentrate on marketing India Inc. for stable foreign direct investment rather than chase portfolio investment by FIIs.
(The author is former executive director, Bombay Stock Exchange).