Foreign Institutional Investment:
Foreign investment flows in the balance of payments (BOP) comprise FDI flows and portfolio flows. The latter consists of resources mobilised by Indian companies through American Depository Receipts (ADRs) and Global Depository Receipts (GDRs). From the trends discernible therein, it follows that the net inflow of investment from both the types of investments was fluctuating till the year 2003. A clear picture, however, appears to be evident after 2004.
Compared to FDI, FII or portfolio investment flows into the Indian economy were not one of the leading varieties of capital flows until 2003-04. In the aftermath of the 1997 East Asian crisis, such flows had actually become net outflows. While there was a modest recovery in 1999-2000, languishing FII flows steadily declined in 2002-03. However, the years 2003-04 and 2004-05, have been remarkably robust years for such flows, Beginning from 1993-94, till 2002-03, the highest share of FII (net) flows in total foreign investment inflows was recorded at 43.5 per cent in 1995-96. During 2003-04 and 2004-05, their share shot up to 79.4 percent and 68.2 percent, respectively, indicating the significant contribution being made by FII investment to the capital account in recent years. During the year 2005-06, FII investment has maintained the healthy trends of the previous two years.
The acceleration in volume of FII inflows in recent years has drawn attention to whether India's capital account is becoming increasingly dominated by 'hot money' - a phrase commonly, but incorrectly, used for describing FII flows - given the tendency of such flows to suddenly reverse the direction in response to adverse market sentiments and precipitating large capital outflows. While theoretically 'herd' behaviour by FIIs and consequent withdrawal cannot be ruled out, such possibilities are limited if the fundamentals are strong, the market is well regulated and the participants are mainly pension funds, life insurance companies and mutual funds, which are more involved with longer tern investments. Hence notwithstanding a quantum jump in volume of FII flows in recent years, low levels of short- term debt as a proportion of total external debt and adequate reserve coverage mitigate the risk of potential reversals.