Transmission Effects of Exchange Rate on Foreign Institutional Investments in India

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2010 International Conference on E-business, Management and Economics IPEDR vol.3 (2011) © (2011) IACSIT Press, Hong Kong

Transmission Effects of Exchange Rate on Foreign Institutional Investments in India Dr.Raju.G
Professor and Head, Department of Management Studies, GCET Greater Noida, U.P, India-201308. e-mail:

Santosh Kumar
Lecturer, Finance and Accounts, Amity Business School, Noida, India e-mail:

Tanveer Shahab
Lecturer, GEMA Institute of Management, New Delhi, India e-mail:

Lecturer in Economics, Amity Business School, Noida, India e-mail:

Ashish K Khatua
Senior Manager, Business Analysis, Tata Steel Ltd, Jamshedpur, India. e-mail: Abstract-The ever increasing number of FIIs (Foreign Institutional Investors) and their investments from various countries in various denominations in the last ten years has drawn the attention of policy makers and investors. This paper attempts to investigate the direction and dynamic interaction between four major exchange rates viz. Dollar, Euro, Pound and Yen and net FII flows in India using daily data of exchange rates and net FII flows. The direction of relationship is also computed by using Granger Causality Test and the dynamic interaction is quantified by VAR results and Impulse Response Function at six lags. Results show that dollar exhibit bi-directional relationship whereas pound and yen have one sided influence on net foreign institutional investments. Further it is also evident from Impulse Response Function that exchange rate shocks die out in two days whereas net FII flows contain it for five to six days. On the other hand regression results validate that the net FII flows are positively correlated to rupee appreciation in dollar and yen and negatively correlated to rupee appreciation in pound and euro, but euro have insignificant influence in Indian economy. Key Words: Impulse Response Function, VAR, FII, Exchange Rate JEL Codes: G11, G15



The increased spread of globalization of economies has opened up their doors for overseas capital flows world over. This phenomenon has resulted in the in depth participation of foreign institutional investments in the stock market. It

provided much needed capital at firms and sectoral levels to make their presence felt in overseas market destinations. Due to this continuous shift in the economic structure of scope and area of business, exchange rates gained attention and became an important determinant for sustainable business operations. This growing significance has made FII’s and exchange rates, two very important variables for economy. With a shift of exchange rate, profitability margin keeps changing as well as changes take place in foreign exchange reserves valuation and it results in to the FII’s inward /outward movement in stock market. Similarly, FII’s inflows in the stock market enhance the foreign exchange reserve resulting in to the exchange rate movement and vice versa. This cause/effect relationship between FIIs and exchange rates has been the focus area of research across the globe and any consensus about the nature of relationship is yet to be established. This research work has been an effort to identify the transmission effect of FII’s in Indian stock market upon exchange rates. FIIs in stock market and exchange rates have become important variables for any economy more specifically in post liberalization era. Cause effect linkage between these two variables has been the subject of extensive research for the last decade. Badhani (2005) studies the relationship among stock prices, Dollar –Rupee exchange rate and net FII investment in India and finds long term relationship between FII capital flow and stock prices as well as between FII investment flow and exchange rate. Kumar (2009) studies the relationship between Exchange rate and FII with stock returns in...
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