Press Release – Foreign investors do not destabilise Indian stock market

Foreign investors do not destabilise the local Indian stock market and instead can bring additional capital into the economy during boom times.

The research, presented by Nirvikar Singh (University of California, Santa Cruz) and co-authored by Ila Patnaik and Ajay Shah (both National Institute for Public Finance and Policy, India) at the International Growth Centre’s South Asia Growth Conference 2013, argues that there is no evidence for foreign portfolio investors bringing crises with them into the local Indian stock market. While they can exacerbate extreme movements in stock price returns, they can also help to stabilise prices and bring capital to the market.

The research also finds that sharp outflows of foreign investment, caused for example by a bad day on the Indian stock market, do not unduly destabilise the market. Singh and co-authors find that foreign investors do not have a major impact on domestic markets through large movements of funds.

Background

While developing countries have eased capital controls in recent decades, many policymakers continue to be concerned about the problems associated with financial globalisation. Emerging market policymakers are particularly concerned about the financial stability consequences of foreign portfolio flows.

This research focuses on the behaviour of foreign investors under extreme conditions, that is, what do foreign investors do when there is an extreme event, measured as a sharp market movement, in either the domestic or foreign economy.

Key findings

  • Foreign investors’ behaviour in response to extreme conditions does not destabilise the Indian stock market.
  • There is no evidence that foreign investors bring crises with them into the local Indian stock market.

Policy implications

  • There is much debate about allowing large inflows of foreign investment into India as policymakers have been concerned that they can trigger bubbles and crashes in the local economy. The key fear is that sharp inflows and outflows of portfolio investment can destabilise the Indian stock markets. This research shows that such fears may be unfounded, with foreign portfolio investment not necessarily exacerbating sharp market movements.

Research aim

The aim of the research was to better understand the impact of foreign investment in India, focusing in particular on the behaviour of foreign investors under extreme conditions such as a domestic crisis.

Research method

The research used daily data for Indian stock market returns, net foreign investment inflow, the US S&P 500, and the VIX. They also observed the ‘call money rate’ as a measure of the domestic interest rate. This data was used to measure forecasted stock market volatility and a bootstrap approach to statistical inference was used to highlight extreme events and allow an understanding of the behaviour of foreign investors during crises.

Researchers

Ila Patnaik is a Professor at the National Institute of Public Finance and Policy. Her main area of research is open economy macroeconomics.

Ajay Shah is a Professor at the National Institute of Public Finance and Policy. His main areas of research are policy issues on Indian economic growth, open economy macroeconomics, public finance, financial economics and pensions.

Nirvikar Singh is a Professor of Economics and holds the Sarbjit Singh Aurora Chair in Sikh and Punjabi Studies at the University of California Santa Cruz. He also directs the Business Management Economics Program and the UCSC South Asian Studies Initiative. He is a member of the Advisory Group to the Finance Minister of India on G-20 matters.

 

This statement was issued at the South Asia Growth Conference 2013, held in New Delhi, India.