29-11-2012, 06:27 PM
IMPACT OF FII’S AND FDI’S ON INDIAN STOCK MARKET
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Introduction
When people think about globalization, they often first think of the increasing volume of trade in goods and services. Trade flows are indeed one of the most visible aspects of globalization. But many analysts argue that international investment is a much more powerful force in propelling the world toward closer economic integration. Investment, often alters entire methods of production through transfers of know-how, technology and management techniques, and thereby initiates much more significant change than the simple trading of goods.
Over the past ten years, foreign investment has grown at a significantly more rapid pace than either international trade or world economic production generally. From 1980 to 1998, international capital flows, a key indication of investment across borders, grew by almost 25% annually, compared to the 5% growth rate of international trade. This investment has been a powerful catalyst for economic growth.
But as with many of the other aspects of globalisation, foreign investment is raising many new questions about economic, cultural and political relationships around the world. Flows of investment and the rules that govern or fail to govern it can have profound impacts upon such diverse issues as economic development, environmental protection, labour standards and economic stability.
Forms of Foreign Investment
International investment or capital flows fall into four principal categories:
Commercial loans: These primarily take the form of loans by banks to foreign businesses or governments.
Official flows: This category refers generally to the forms of development assistance given by developed countries to developing ones.
Foreign Direct Investment (FDI): This category refers to international investment in which the investor obtains a lasting interest in an enterprise in another country. FDI is calculated to include all kinds of capital contributions, such as the purchases of stocks, as well as the reinvestment of earnings by a wholly owned company incorporated abroad (subsidiary), and the lending of funds to a foreign subsidiary or branch. The reinvestment of earnings and transfer of assets between a parent company and its subsidiary often constitutes a significant part of FDI calculations. An investor's earnings on FDI take the form of profits such as dividends, retained earnings, management fees and royalty payments.
Foreign Portfolio Investment (FPI): FPI is a category of investment instruments that are more easily traded, may be less permanent, and do not represent a controlling stake in an enterprise. These include investments via equity instruments (stocks) or debt (bonds) of a foreign enterprise which does not necessarily represent a long-term interest. The returns that an investor acquires on FPI usually take the form of interest payments or non-voting dividends. Investments in FPI that are made for less than one year are distinguished as short-term portfolio flows.
Until the 1980s, commercial loans from banks were the largest source of foreign investment in developing countries. However, since that time, the levels of lending through commercial loans have remained relatively constant, while the levels of global FDI and FPI have increased dramatically. Over the period 1991 - 1998, FDI and FPI comprised 90% of the total capital flows to developing countries.
Similarly, when viewed against the tremendous and growing volume of FDI and FPI, the funds provided in the past by governments through official development assistance, or lending by commercial banks the World Bank or IMF, are diminishing in importance with each passing year. When one talks about the recent phenomenon of globalization therefore, one is referring in large part to the effects of FDI and FPI, and these two instruments will therefore be the primary focus of this issue brief.
Calculating Investment:
Calculations of FDI and FPI are typically measured as either a "flow," referring to the amount of investment made in one year, or as "stock," measuring the total accumulated investment at the end of that year.
Differences Between Portfolio and Direct Investment
One of the most important distinctions between Portfolio and Direct investment to have emerged from this young era of globalisation is that portfolio investment can be much more volatile. Changes in the investment conditions in a country or region can lead to dramatic swings in portfolio investment. For a country on the rise, FPI can bring about rapid development, helping an emerging economy move quickly to take advantage of economic opportunity, creating many new jobs and significant wealth. However, when a country's economic situation takes a downturn, sometimes just by failing to meet the expectations of international investors, the large flow of money into a country can turn into a stampede away from it.
By contrast, because FDI implies a controlling stake in a business, and often connotes ownership of physical assets such as a equipment, buildings and real estate, FDI is more difficult to pull out or sell off. Consequently, direct investors may be more committed to managing their international investments, and less likely to pull out at the first sign of trouble.
This volatility has effects beyond the specific industries in which foreign investments have been made. Because capital flows can also affect the exchange rate of a nation's currency, a quick withdrawal of investment can lead to rapid decline in the purchasing power of a currency, rapidly rising prices (inflation) and then panic buying to avoid still higher prices. In short, such quick withdrawals can produce widespread economic crisis. This was partly the case in the Asian Economic Crisis that began in 1997. Although the economic turmoil began as a result of some broader shifts in international economic policy and some serious problems within the banking and financial sectors of the affected East Asian nations, the capital flight which ensued -- some compared it to the great financial panics which took place in the United States during the 19th century -- significantly exacerbated the crisis.
Why Do Companies Invest Overseas?
Companies choose to invest in foreign markets for a number of reasons, often the same reasons for expanding their operations within their home country. The economist John Dunning has identified four primary reasons for corporate foreign investments: