A Study of Relationship between Foreign Institutional Investment and Exchange Rate Movement in India

The issue is contentious since a huge proportion of the population is still devoid of easy access to capital markets for fruitful investments. Often, FIIs do not act rationally and excessive dependence on them can have disastrous consequences for the economy. FIIs are the first to-flee in case of any undesirable circumstances and this necessitates the need for having a strong domestic support. The FII flows also have another dark side. They normally invest in the top-run companies and this creates a buying pressure, which forced the indices upward, quite analogous to the rise in the price of a commodity due to a heightened demand. This leads to a cascading effect on even the undeserving stocks among others and because of the heavy manipulation that follows, the promoters and operators manage to escape the scrutiny. As a result, the small investors who are looking for cheap bargains get maneuvered into such stocks. Foreign Institutional Investors are now allowed to invest in equity, debts and derivative instruments subject to the limits of foreign ownership as well as ceilings on total investment per investor. As FII affects the real economy of India via rate of exchange and many other factors, there is a need to study the effect of FII (both equity and debt) on the movement of foreign rate of exchange (rupee to US dollar).

This paper aims to study and identify the relationship between foreign capital flow andrate of exchange in India for the period January 2006 to January 2015 using monthly data. The data includes the Inflow of FII both Equity and Debt into India, Net FII, and Rate of exchange between Indian Rupee to US Dollar. Foreign investors are attracted to success stories; they are drawn to countries already growing, politically stable, and with a sizable purchasing power. It is attracting towards high rate of interest and large market size as well as certain level of scope for new business and innovative ideas. Foreign investment inflows to India continued to increase over the last two decades as a result of investment favourable policies adopted by the Indian government. There is sufficient evidence to show that there is significant relationship foreign capital flow on foreign rate of exchange. Research concludes that there exists unidirectional causality in the movement of FII investment in equity, Debt and the movement of rate of exchange in India.