This article discusses the importance of the FIIs in the Indian economy and the stock markets. It also looks at the reasons behind the slowdown of FIIs. It further goes into the macroeconomic explanations for the need of FII inflows for any economy.

Foreign Institutional Investors (FIIs) played an important role in the Indian equity markets, and prior to that Non-Resident Indians (NRIs) and Overseas Corporate Bodies (OCBs) gave full support to initiate portfolio investment in India. Early in the year 2000-01, the total FII investments in India accounted for over 37% to 47% of the current account deficit. A major part of it came from FIIs and mostly in the form of equities bringing adequate channels of international portfolio investment in India for foreigners. From then onwards, it gradually expanded its scope to an average monthly inflow of approximately Rs. 1,900 cr during the first half of 2001. By the end of June 2001, over 500 FIIs were registered with Sebi. The total amount of FII investment in India was a formidable sum of over Rs. 50,000 cr during the same period. In terms of market capitalization too, the share of FIIs steadily reached to about 9% of the total market capitalization of Bombay Stock Exchange (BSE) (which, in turn, accounts for over 90% of the total market capitalization in India) and the net FII inflows have grown to be the single largest contributor to capital market inflows.

The recent surge in the Indian equity markets, which often is not directly linked to the activity of the FIIs is reflecting a close correlation between the BSE Sensex and FII fund flows. Quite interestingly, the FIIs have a disproportionately high level of influence over the market sentiments and pricing movements in the Indian equity market as other market participants are perceived to follow the activities of FIIs.

From the chart it is clearly evident that Indian equity markets were more or less in a steady line till April 2003, when FII inflows per month tended to follow a normal historical trajectory. The ups and downs in the FII inflows in May 2003 have also led to quantum jumps in the BSE Sensex. But despite the general upward trajectory, the BSE Sensex has seen correction for months and such corrections occurred with negative FII flows. There is no doubt therefore that the BSE Sensex fell by 14% in May 2006 compared to April 2006 after FIIs turned net seller and sold to the extent of $1.6 bn in that single month. In May 2006, FIIs pulled out Rs. 7,400 cr from Indian equities, contributing to the fall in Sensex by around 28%.