Impact of Foreign Institutional Investment on Indian Stock Market: A Cause and Effect Relationship

Abstract

The growing Indian market had attracted the foreign institutional investors (FIIs) to Indian equity market during post financial reform period. The present article made an attempt to explain the short-term and long-term causal relationship between FIIs and Indian stock market. The study uses the monthly time series data on advances to declines ratio (ADR) of Bombay Stock Exchange (BSE) and purchases to sales ratio of FIIs. The sample period spans from April 2001 to December 2012. To attain the intent of the study, the article employs the empirical techniques such as co-integration, Granger causality test and variance decomposition analysis as a part of research methodology.

The result of co-integrating relationship discloses the rejection of null hypothesis of no co-integrating vectors which implies the existence of a long-term relationship between the dependent and the independent variables. Further, the Granger causality reveals the presence of unidirectional causality running from FIIs to BSE-ADR during short as well as long span of period. The variance decomposition analysis clearly shows that the price changes in BSE are influenced to a very large extent by innovations in FIIs and confirms the dominant role of FIIs in information dissemination. Thus, the results suggest that BSE is significantly affected by FIIs and the latter is not influenced by variations in the BSE, that is, there exists unidirectional causality running from FIIs to BSE-ADR.