The destabilising foreign hand
Financial Express, June 6, 2006
Are Indian equity markets driven by FIIs? What is the share of FII
ownership in Indian companies? How to FII's choose which company to
invest in, and whether to stay invested in the company or leave? If we
are to understand, rather than fear, what Indian pink papers often
call "an FII driven market" we need to start with the facts. This was
the objective of a recent study (http://tinyurl.com/o8nk3), Ajay Shah
and I did using data for all companies listed on BSE or NSE.
We found that evidence contradicts some widely held beliefs. For
example, it is believed that FIIs "dominate" the equity
market. However, the data suggests that their role is fairly
limited. Price formation today primarily takes place on the equity
derivatives market. The latest data shows that all institutional
investors - domestic plus FII - add up to roughly 8 percent of the turnover on
the equity derivatives market. To attribute domination to something
smaller than 8 percent would be like asking the tail to wag the dog. On the
equity spot market also, the share of FIIs in trading works out to a
value like 8 percent.
In a more rigourous econometic analysis examining causality, we
analyse daily data for net FIIs flows. Interestingly, we do not
find a clear causality where higher net FII flows lead to higher stock
prices, or vice versa. If anything, our analysis suggests a reverse
causality: that when Indian stock prices do well, FII inflows come in;
when Indian stock prices do badly, FII outflows take place. Our
evidence suggests that atleast so far, FIIs are followers, not
leaders. This may well change in the future, if FII participation on
the equity market goes from 8 percent to (say) 50 percent. But until then, the
widespread belief about the "domination" of FIIs needs to be
questioned.
This result is supported by annecdotal evidence. As an example, in
the latest two weeks of a sharp drop in stock prices, the exit by FIIs
has been remarkably small. FIIs have been buying on the equity
derivatives and selling on the spot. If we add up, the total net sale
by FIIs works out to an average of roughly Rs.500 crore per day. This
is a small value considering that on most days, the total volume (NSE
plus BSE, spot plus derivatives) works out to roughly Rs.50,000 crore
per day.
How big is the share of FIIs in the ownership of individual firms?
Here we find that FII ownership is concentrated in a small number of
firms. In March 2005, there were only 332 companies where FII
ownership exceeded 5 percent. This is a tiny fraction of the 2600 companies
in India where a meaningful extent of equity market trading takes
place. In total FIIs own 11 percent of all companies. Their
share has risen from 8.5 percent in 2001 to 11.1 percent in 2005.
Sometimes, it is felt that FIIs are capricious and unpredictable. It
is felt that hedge funds weave from one company to another, making
huge money driving up stock prices, and damaging the cost of capital
when they choose to dump a company. What does the evidence say?
While there are only 332 companies with FII ownership exceeding 5
percent, these companies appear to have been selected for some
characteristics. FIIs seem to care about 3 things: size, liquidity and
corporate governance. In other words, if a company wants to attract
foreign shareholders, it needs to be big, it needs a liquid secondary
market for the stock, and the managers need to be very careful to not
steal from the shareholders. Once companies achieve FII investment,
this tends to stay. There is an 82 percent chance that a company with
over 5 percent FII investment will continue to have this, after a
period of one year. This makes FIIs looks more like a stable source of
equity capital than a capricious and unreliable bunch.
It is easy to be xenophobic about FIIs and slip into the stance of
Mahathir Mohammad, where white men are seen as another East India
Company. But it makes more sense for us to understand the rules of the
game and the forces at work in globalisation, and then set about
putting our house in order so as to exploit the benefits.
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