Impact of Foreign Institutional Investment on Exchange Rate Movement in India

Abstract

Post opening up of the borders for capital movement, foreign investment in India has grown enormously and the country has emerged as one of the most favoured destinations for global investment. 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. We cannot deny the need of foreign capital to build foreign exchange reserves to meet trade deficit and increase the productivity of labour. As FII affects the real economy of India via exchange rate and many other factors, there is a need to study the effect of FII (both equity and debt) on the movement of foreign exchange rate (rupee to US dollar). This paper attempts to analyse the impact of foreign institutional investment on the foreign exchange rate in India. Historical data of monthly values of FI’s investment in equity, debt investment and exchange rate from 2000 to 2011 has been taken and cause and effect research design is used for data analysis by using statistical and financial econometric tools like descriptive analysis, unit root test, ADF test, Vector Auto Regression (VAR) to test the impact of FII on exchange rate in India. Research concludes that there exists unidirectional causality in the movement of FII investment in equity and the movement of exchange rate in India. However, no causal relation is found in case of FII debt investment on the exchange rate movement in India.

Keywords: Foreign Institutional Investment (FII), Exchange Rate, Transnational Capitalism, Portfolio Investments

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