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Stock markets: FIIs bullish

May 16, 2003

One good indicator of investor confidence in an economy and its stock markets is seen from the level of foreign institutional investments. In the Indian context, foreign institutional investors (FIIs) seem to have been the laggards. The graph below may indicate that there is a reasonably strong correlation between FII investments and Sensex movement over the years. However, FII investments as a percentage of market capitalisation of the BSE Sensex is still too low and this has led us to believe that FII investments in the country are not directly responsible for any strong movement in the Indian indices.

Influx of FII money into capital markets is a good indicator of the valuation and/or growth prospects of not only the country's capital markets but also of the economy as a whole. It must be noted here that stock markets tend to reflect the country's growth prospects. Strong FII participation is also good from the domestic investor point of view in the sense that it leads to enhanced market capitalisation and increased investor confidence.

On the other hand, over-dependence on FIIs could be devastating for the stock markets because when these institutions pull out their money from the markets, it leads to panic amongst small investors. Retail investors are the biggest losers in such a scenario. Again in the Indian context these worries are not warranted as FII investments as a percentage of total market capitalisation of the indices is still too low. Even though we feel that there is no direct correlation between FII inflow and the movement of indices, we believe that Indian investors tend to take a cue from FIIs. This indicates an indirect influence of FII investments on Indian sentiments and consequently the stock markets.

Considering the above argument the heartening news is that since the beginning of 2003, FIIs have been actively buying into Indian equities (over US$ 900 m to date compared to about US$ 650 m in the corresponding period last year). Apart from the strong fundamentals of the country, there could be other factors that could have added to the increased inflow of FII investments into India. One major reason could be the outbreak of the Severe Acute Respiratory Syndrome (SARS) in China and its neighbouring countries like Honk Kong and Singapore, which are some of the key investment destinations of the FIIs.

Going forward, it seems that the interest of the foreign institutional investors will continue towards India, as it is one of the fastest growing economies in the world. Moreover, with the governments measures towards reforms (banking and power) and infrastructure development economic growth will be fueled further thus creating value for investors over the long term.

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