Journal of Economics, Management and Trade 20(1): 1-14, 2017; Article no.JEMT.38090 ISSN: 2456-9216 (Past name: British Journal of Economics, Management & Trade, Past ISSN: 2278-098X) Role of the FIIs in the Development of the Indian Stock Market: An Econometric Analysis Harshit Agarwal1* and Rashi Agarwal2 1Department of Economics and Finance, Portsmouth Business School, University of Portsmouth, University House, Winston Churchill Ave, Portsmouth PO1 2UP, United Kingdom. 2Department of Finance and Economics, Southampton Business School, University of Southampton, University Rd, Southampton SO17 1BJ, United Kingdom. Authors’ contributions This work was carried out in collaboration between both authors. Author HA designed the study, performed the statistical analysis, wrote the protocol and wrote the first draft of the manuscript. Author RA managed the analyses of the study and the literature searches. Both authors read and approved the final manuscript. Article Information DOI: 10.9734/JEMT/2017/38090 Editor(s): (1) Chiang-Ming Chen, Department of Economics, National Chi Nan University, Taiwan. Reviewers: (1) Jones Osasuyi Orumwense, University of Namibia, Namibia. (2) Sylvester Ohiomu, Edo University, Nigeria. Complete Peer review History: http://www.sciencedomain.org/review-history/22197 Received 10th November 2017 th Original Research Article Accepted 30 November 2017 Published 7th December 2017 ABSTRACT The stock market of a country operates in the economy of that country and the economic conditions of the country affect the stock prices of the stocks listed in the stock exchanges of the country. And it is believed that macroeconomic variables of a country and the stock prices of the stocks listed in the stock exchanges of the country are co-integrated. In this paper, in the context of India, the relationship of 8 macroeconomic variables with the stock market was examined. These variables are IIP, WPI, Gold Price, M3, Call Money Rate, FIIs Investment, Real Effective Exchange Rate and Foreign Exchanges Rates. Two periods have been taken for the study, 1991 to 2002 and 2003 to 2016. 1991 to 2002 saw a flat stock market growth and 2003 to 2016 saw exponential growth. The credit of this exponential growth in the latter period is given to the Foreign Institutional Investors Investments (FIIs). By employing the Bi-variate Johansen Co-integration Test, Granger Causality Test and the Step-wise Regression, it was concluded that during 1991 to 2002 no macroeconomic variable affected the stock market in the long-run and during 2003 to 2016 only FIIs were able to influence the stock market in the long-run. _____________________________________________________________________________________________________ *Corresponding author: E-mail: [email protected], [email protected]; Agarwal and Agarwal; JEMT, 20(1): 1-14, 2017; Article no.JEMT.38090 Keywords: Indian stock market; FIIs; macroeconomic variables; post-2003; foreign investment. 1. INTRODUCTION taken because of the different movement of the stock market between these periods. 1991 to The stock market of a country operates in the 2002 showed flat growth and 2003 to 2016 economy of that country, the economic showed extraordinary growth. Then in the next conditions of that country will affect the sales, section effect of GDP will be analyzed on the revenues, profits, borrowings, investments, stock market. Then by forming a panel investor sentiment and eventually the stock regression effect of G20 economies’ on their prices of the companies listed on the stock respective stock markets will be seen. And then exchanges of that country. Thus, it is said that a state level analysis will be done in which state the macroeconomic variables of a country affect variables of India will be taken and their effect the stock market of that country and share a will be seen on the Indian stock market. long-run co-integration. 2. LITERATURE REVIEW In this part, we will we will analyze the effect of the macroeconomic variables of India on the A short review of the researches done in the past Indian stock market by taking 8 variables into two decades on the effect of the macroeconomic account. Periods will be taken from 1991 to 2002 variables on the Stock Market. and 2003 to 2016. Different periods have been Table 1. Researches on the impact of the macroeconomic variables on the stock market Research title Researchers and Research aim Research outcome publication The Impact of (Giri and Joshi, To check whether There exists a long-run Macroeconomic 2017) [1]. there is an equilibrium relationship between Fundamentals relationship between macroeconomic variables and on Stock Prices several stock market index because Revised: A macroeconomic they are cointegrated. Bi- Study of Indian variables and stock directional Granger causality is Stock Market market index in the also present for some variables. long run or not Dynamic (Laopodis and To establish the There is a highly positive interactions Papastamou, 2016) influence of significant relationship between between stock [2]. macroeconomic the movement in the stock markets and variables on the market and the change in the the real movement of the stock exchange rate and crude oil. economy. market The Impact of (Islam and Habib, To examine the Amongst 10 variables 3 factors Macroeconomic 2016) [3]. influence of are selected which are positively Variables on macroeconomic reflected and show the Indian Stock variables on the Indian significant result in influencing Market using stock market the stock market. Factor Analysis performance with the Approach. relevance of emerging markets using factor analysis approach. The cross- (Wang and Di Iorio, To analyze the Results show that the firm sectional 2007) [4]. relationship between characteristics like the size and relationship some characteristics book to market ratio are between stock specific to firms, a significant to influence the stock returns and local beta, two local returns and the findings also domestic and betas and the stock show that the global stock global factors in market returns using markets and the Hong Kong the Chinese A- the Fama and stock market do not influence share market Macbeth approach. the Chinese A-share market. 2 Agarwal and Agarwal; JEMT, 20(1): 1-14, 2017; Article no.JEMT.38090 Research title Researchers and Research aim Research outcome publication Globalization (Lam and Ang, To measure the extent Both macroeconomic factors and stock 2006) [5]. to which domestic or and global market risk factor market returns global risk factors can significantly affect the stock influence the stock market returns and in case of market returns. developed markets domestic factors provide four times less explanatory ability than the global factors Cointegration (Kwon and Shin, To explain whether the Indices of stock prices are and causality 1999) [6]. stock market returns in Cointegrated with some chosen between Korea is affected by macroeconomic variables and macroeconomic the current economic hence there is a long run variables and activities using equilibrium relationship and the stock market Cointegration, Granger key finding is that the price returns causality and the indices of stocks are not the top VECM tests. indicator for variables. 3. RESEARCH GAP contributed in the economic stagnation and dismal growth rates from 1947 to 1990s. From the literature, it was quite clear that there is still scope for analyzing the impact of the FIIs on In 1990 there came a period when India was in a the Indian stock market. We have taken two serious economic crisis and the Indian periods for our analysis for testing the effect of government was on the verge of bankruptcy. It the macroeconomic variables on the Indian stock had money left to import only 3 weeks of imports market. First pre-2003 and second post-2003, and Indian government was forced to go to the the Indian stock market growth post-2003 are IMF for help, it had to pledge 67 tonnes of gold largely credited to the FIIs. Pre-2002, the growth and as per the conditions of the IMF, it had to of the stock market was flat and there was no forcefully accept economic reforms. It had to significant role of the FIIs. And this two-period open its markets for the foreign investors, study will help us find the impact of the FIIs on dismantle controls over the economy, had to the Indian stock market which has not been done break state monopolies on the businesses and till now. had to reduce tariffs. And this event in the history of Indian economy is popularly known as 4. INDIAN ECONOMY PRE AND POST Liberalization of 1991. LIBERALIZATION AND THE BOMBAY STOCK EXCHANGE It was the result of the liberalization that from $132 million in 1991-92, foreign investment India became independent from the British rule in reached to $5.3 billion in 1995-96. The real fruits 1947, since independence till 1990s India was of the reforms started to come in the 2000s when only able to grow at a rate of 3 to 3.5% annually. Indian economy started to grow in double digits The capital growth rate was even worse at annually. And the biggest impact which economic around 1.3%. The main reason behind this slow reforms of 1991 had was on the Bombay stock growth was centralized-economic planning- exchange of India. model followed by the Indian government after the independence. This model was inspired by Bombay stock exchange is the Asia's oldest the Soviet Union socialist-economic model. It stock exchange which began 140 years ago was this model which gave rise to extensive under a banyan tree. It has been India's primary bureaucracy, red tape, unnecessary regulations stock exchange for a long time, it is today the and trade barriers in India. India's protectionist 11th largest stock exchange in the world in terms policies, Nehru's five-year plans, License Raj of market capitalization.