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Exploring the Causality for FIIs’ Investment Deviations in India Amiya K. Sahu[1], Amrita Chakraborty[2]
Abstract
As an emerging market, India has been attracting foreign investments since 1993. In the equity market, Foreign Institutional Investors’ (FIIs’) net investments have grown at a CAGR of 21% since then. What causes the attraction? Several studies (Griffin, 2004; Sehgal and Tripathy, 2009; Bodla and Kumar, 2009) have empirically found that FII investments have a significant bearing on Indian markets at an aggregate level. Do they monitor company fundamentals and enjoy information asymmetry? Can other investors follow FIIs? We investigate association between institutional (FII) ownership and stock fundamentals. This study uses a large sample balanced panel data model and support for our hypothesis testing for the period of 2001-2010. We find that the quarterly changes in FII holding has unidirectional and bidirectional causal interactions with lagged indicators between FIIs’ holding and company fundamentals. Hence, if FIIs’ investments are mocked (retail investors), one may have a good recipe for profits. Our results can also imply that FIIs can have significant contribution in controlling agency problem and adding to existing literature on shareholder activism. Key words: India, Foreign Institutional Investor shareholding, Company fundamentals, Granger causality, Agency problem. Corresponding Author

Amiya K. Sahu
Assistant Professor
Goa Institute of Management
Poriem, Sattari, Goa - 403505
Tel: 0832 -2366700; Hand Phone: 09861762648
Email: amiyasahu@rediffmail.com
Registration No: 1109
Exploring the Causality for FIIs’ Investment Deviations in India

1. Introduction

Until the 1980s, India focused on self-reliance and there was disinclination towards foreign investment. Ever since the economic reforms were launched in the early 1990s, Indian markets were opened to attract foreign investments in different formats. Foreign investments augment domestic investments. Increase in equity market investments lead to higher stock returns and encourage investments by Indian firms. The equity portfolio investment by foreign institutional investors (FIIs) although were initially restricted, gradual relaxations were made. At present, all restrictions have been lifted (except capping in some sensitive sectors). The portfolio investments by FIIs have expanded along with those of private mutual funds in the same period. As strong economic fundamentals were observed, FII attractions to Indian equity market became stronger. Though there were negative net investments in some years, primarily due to events in other economies, FIIs have come back making substantial investments in subsequent years. The net investments by FIIs have grown at about 21% (CAGR) since 1993. FIIs investments have been found to have caused market returns at aggregate levels. Chakrabarti (2001) found that the FII net inflows were not only correlated with the return in Indian equity market but was more likely the effect than the cause of the Indian equity market return. Mukherjee et al. (2002) found that the FII activities had a strong demonstration effect and was driving the domestic market suggesting that the FII flows tend to be caused by return in the domestic market. Griffin (2004), found that foreign flows are significant predictors of returns for Korea, Taiwan, Thailand and India, indicating that foreign investors are buying before market index increases. More recently, Babu and Prabheesh (2008), have shown bidirectional causality between FII flows and stock returns. Sehgal and Tripathy (2009) have reported that FIIs adopt positive feedback and herding strategies in Indian market using monthly data. Bodla and Kumar (2009) found evidence of FIIs investments causing market capitalization. Khan et al. (2010) found positive unidirectional causality between Nifty and FIIs. Many studies (Choe et al., 1999; Froot et al., 2001; Clark and Berko, 1997;...
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