An Analysis on the Effect of Foreign Direct Investment and Foreign Institutional Investment Flows on Indian Stock and Capital Market: The Impact of Foreign Investments on the Indian Stock Market

Abstract

Foreign investment wasintroduced in 1991 under Foreign Exchange Management Act (FEMA). This step wastaken to add some source of capital formation in India as other developingeconomies were already in this practice. As a result inflow of Foreign Capitalhas become striking measure of economic development in both developed anddeveloping countries Now the developing countries are witnessing changes in thecomposition of capital flows in their economies because of the expansion andintegration of the world equity market. FDI and FII thus have become instrumentsof international economic integration and stimulation. The Indian stock marketsare also experiencing this change. FDI & FII are becoming important sourceof finance in developing countries including India. It is widely assumed thatFDI & FII along with some other external factors such as global economiccues, Exchange rate and Internal factors such as demand and supply, marketcapitalization, EPS generally drive and dictates the Indian stock market. Unprecedented globalizations have witnessed double digit economicgrowth resulting in fierce competition and accelerated pace of innovation. As aresult inflow of Foreign Direct investments has become a striking measure ofeconomic development in both developed and developing countries. FDI and FIIthus have become instruments of international economic integration andstimulation. Fast growing economies like Singapore, China, Korea etc haveregistered incredible growth at onset of FDI. Though US captures most of theFDI inflows, developing countries still account for significant growth of FDIand rise in FII. FDI not only gives access to foreign capital but also providesdomestic countries with cutting edge technology, desired skill sets, tools ofinnovation and other complementary skills. The policies drafted to stimulatethe flow of foreign capital in to India provided much needed impetus for Indiato emerge as an attractive destination for foreign investors. External factorssuch as global economic cues, FDI & FII, Exchange rate and Internal factorssuch as demand and supply, market cap, EPS generally drive and dictates theIndian stock market. Sensex and Nifty were considered as the representative of stock marketas they are the most popular Indian stock market indices. Based on 11 yearsdata starting from 2001 to 2011, it was found that the flow of FDI & FIIwas moving in tandem with Sensex and Nifty. The study concludes that Flow ofFDIs and FIIs in India determines the trend of Indian stock market.