India is the third largest economy in the world in PPP terms. India is the most favourite equity market for global investors.

Of the different types of Foreign Investment, FII is an investor or investment fund registered in a country outside of the one in which it is investing. They are registered as FIIs in accordance with Section 2(f) of the SEBI (FII) Regulations, 1995.

The foreign investments in India are regulated by the Reserve Bank of India by the provisions of Foreign Exchange Management Act, 1999 (relevant sections 6 & 47). FDIs and FIIs are defined in Schedule 1 & 2 in FEMA (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000. SEBI acts as the nodal point in the registration of FIIs. FIIs by individuals cannot exceed 10% of paid-up capital of a company while foreign corporates or individuals registered as sub-accounts of FII cannot exceed 5% of paid-up capital.

A Foreign Institutional Investor may invest only in the following:-

  1. Securities in the primary and secondary markets including shares, debentures and warrants of companies listed or to be listed on a recognised stock exchange in India; and
  2. Units of schemes floated by domestic mutual funds including Unit Trust of India, whether listed on a recognised stock exchange or not
  3. Units of scheme floated by a collective investment scheme
  4. Dated Government Securities
  5. Derivatives traded on a recognised stock exchange
  6. Commercial papers of Indian companies
  7. Rupee-denominated credit enhanced bonds
  8. Security receipts
  9. Indian Depository Receipt
  10. Listed and unlisted non-convertible debentures/bonds issued by an Indian company in the infrastructure sector, where ‘infrastructure’ is defined in terms of the extant External Commercial Borrowings (ECB) guidelines
  11. Non-convertible debentures or bonds issued by Non-Banking Financial Companies categorized as ‘Infrastructure Finance Companies’(IFCs) by the Reserve Bank of India
  12. Rupee-denominated bonds or units issued by infrastructure debt funds
  13. Indian depository receipts; and
  14. Such other instruments specified by the Board from time to time.

Following foreign entities/funds are eligible to get registered as FII

  1. Pension Funds
  2. Mutual Funds
  3. Investment Trusts
  4. Banks
  5. Insurance Companies / Reinsurance Company
  6. Foreign Central Banks
  7. Foreign Governmental Agencies
  8. Sovereign Wealth Funds
  9. International/ Multilateral organization/ agency
  10. University Funds (Serving public interests)
  11. Endowments (Serving public interests)
  12. Foundations (Serving public interests)
  13. Charitable Trusts / Charitable Societies (Serving public interests)

FIIs are the major source of liquidity in the Indian market. High volumes of FIIs indicate confidence in the Indian market and hints at the strong base of the domestic stock market to domestic investors. Foreign institutional investors can supplement domestic savings and augment domestic investment without increasing the foreign debt of the country. Such investment constitutes non-debt creating financing instruments for the current account deficits in the external balance of payments

The advantages and disadvantages are mentioned below

Advantages

  1. Enhanced Flow of Capital

It helps in the growth rate of the investment whereby development projects – economic and social infrastructure is built and so does boosts production and employment and income of the host country.

  1. Managing Uncertainty and Controlling Risks

It helps promote hedging instruments and improve the competition in the financial market and also the alignment of assets which help in stabilizing markets.

  1. Improved Corporate Governance

The FIIs constitute professional bodies like financial analysts who through their contribution to better understanding improve firms’ operations and corporate governance and overcome problems of principal-agent.

Disadvantages

  1. Potential Capital Outflow

Since FIIs are controlled by investors there can be sudden outflow from markets leading to a shortage of funds.

  1. Inflation

The huge inflow of FII funds creates high demand for the rupee and whereby pumping a huge amount of money by the RBI into the market. This creates excess liquidity creating inflation.

  1. Adverse Impact on Exports

With FII inflows leading to an appreciation of the currency, exports become expensive which ultimately leads to lower demand and hence shortfall in the export of goods, reducing competitiveness.

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