Three initiatives — the BSE’s direct market access (DMA) facility for foreign portfolio investors, exemption of foreign portfolio investors from Minimum Alternative Tax and permission by the RBI to enhance participation of foreign investors in government securities — together offer a boost for inflow of foreign funds and at the same time pose a challenge to the RBI in moderating liquidity growth as well as keeping inflation under control.

FIIs account for 19-27 per cent of all equity shares traded on Indian exchanges, against 7-9 per cent from domestic institutions. As such foreign inflows have a significant participatory role in the Indian equity market.

The DMA facility and such other incentives from the government, such as allowing Indian companies to issue partly-paid shares to FPIs/FDIs, will surely increase the volume of total equity trade as well as share of FIIs.

However, FIIs have pulled out of the country whenever better investment returns emerged elsewhere. Indian authorities have to manage future volatility, avoiding a contagion impact. In fact, in 2014-15 net investment by FIIs worked out to only 18 per cent of their gross investments and ranged around -7 per cent during April to June 2015-16.

Further analysis of month-wise purchase of equities by FIIs during this period reveals an antiseptic investment approach by domestic institutions.

Though they bought during the downward period and sold in buoyant period, the flushing out of FIIs investment could not be replaced by domestic institutions since their investment was much lower than outflows of FIIs.

The equity trade vacillates due to manipulations, greedy actions of market players, insider trading, and policy intervention and exchange rate policies.

These domestic factors can sometimes torpedo steady investment. Though SEBI keeps constant watch on such factors, the globalisation of the markets has speeded up the ability to both invest and withdraw funds to the extent that even financial authorities have a tough time keeping up with the volatility.

How to check this? The Centre is considering constituting a fund by putting together all small pension funds and provident funds to invest in equity markets during periods of volatility. Another move is putting a cap on sale of equity shares by FIIs and making available a fiscal incentive to domestic financial institutions to counterbalance the equity markets during the depression phase. This can be done by exempting domestic institutions from transaction tax.

The cap on FII sales can be fixed for 2-4 years subject to change if necessary. The SEBI should collect daily transaction data to identify abnormal sales/purchase of equity stocks to ferret out those FIIs which create high impact cost for Indian equity market.

The management of FIIs investment and disinvestment may be governed by the RBI policy because the issue is closely linked to monetary policy.

However, a lasting solution to this dilemma is to augment domestic savings by taking financial inclusion to almost each and every village to mobilise savings from households even with small savers and to enhance the productivity of all economic sectors to produce a higher level of GDP at the same cost.

Hence the higher the GDP at the same cost, higher the domestic savings to replace foreign savings inflows. Self dependence confers independence.

The writer is former Economic Advisor, SEBI

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