Comparative analysis of Impact of M1 and M2

of US on FIIs in India

QTBD Project

P Santosh Kumar (09FN-075)Pushkar Kumar Singh (09FN-082)Rajeev Kumar (09FN-088)

Introduction

• This Project studies the impact of Money supplies: M1 and M2 of US on FIIs in India.

• M1:– Consists of highly liquid assets. – All Assets which are easily exchangeable for goods and services– Coins and Currency in circulation, traveler’s checks, demand

deposits, other checkable deposits• M2:

– M1– Slightly less liquid assets like savings account, money market

deposit accounts, small time deposits, retail money market mutual funds

Introduction

• FIIs in India are assumed to be dependent on various macro economic parameters such – Inflation Rate (WPI)– GDP growth rate– Re/Dollar Exchange Rate– NSE returns

• Reasons for FIIs investing in India– Emergence of BRIC countries– Subdued returns offered by stock markets of

developed countries

Objective

• To study the relationship between FIIs in India , Money supply parameters M1 and M2 of US and other macro economic parameters of India

Methodology

• Correlation• Regression

Data Analysis• Data for the variables has been collected

from disparate source for the last ten years. 1999-2008

• All the data was then normalized to monthly format using excel and VBA

Data Analysis

• correlation matrix GDP Returns ER Inflation M1 M2-M1 EM PLR FII

GDP1                

Returns0.63 1              

ER-0.47 -0.72 1            

Inflation0.073 0.26 -0.09 1          

M10.64 0.63 -0.23 0.32 1        

M2-M10.58 0.77 -0.31 0.37 0.93 1      

EM0.65 0.95 -0.73 0.23 0.64 0.78 1    

PLR0.18 0.66 -0.33 0.17 0.42 0.6 0.58 1  

FII0.20 0.02 -0.17 -0.25 0.10 0.03 0.1 -0.12 1

Data Analysis

• Correlation analysis– Stock returns, GDP, Exchange Rate(ER), M1 ,

M2-M1 , EM and PLR(public lending rate) bear positive correlation with FII.

– Inflation bears negative correlation with FII.

Data Analysis

• Regression model (Multi Variate Regression)Ŷ = b0 + b1x1 + b2x2 + b3x3 + b4x4 + b5x5 + b6x6 +

b7x7 + b8x8

Ŷ = FIIX1 = GDP, X2 = Returns, X3 = ER, X4 = Inflation,

X5 = M1, X6 = M2-M1, X7 = Emerging Market index (EM), X8 = Prime Lending Rate (PLR)

Data Analysis

• Regression output using excel

Data Analysis

• Interpretation of results– Adjusted R2 = 0.2194 only 21.94% change

can be explained by this model FII activity does not depend much on these independent variables

– Significance of coefficients of individual variables• P values for GDP,ER and PLR are 0.669,0.793

and 0.88 respectively GDP,ER and PLR do not have statistically significant impact on FIIs

Data Analysis

• Returns, Inflation, M1, EM and M2-M1, have statistically significant impact on the FIIs activity in NSE as their P-values are less than 0.1

• For 4 out of these 5 parameters it can be said that a relationship exists between the FIIs and these parameters with 95% confidence.

– Null Hypothesis• H0:b1 = b2 = b3 = b4 = b5 = b6 = b7 = b8 = 0

– Alternate Hypothesis• H1: b1, b2, b3, b4, b5, b6, b7, b8 ≠ 0

Data Analysis– 2 tailed test– P-value, significance F, is just 0.0000164 Null

Hypothesis is rejected

Conclusion• GDP, Exchange Rate, Prime Lending Rate (PLR)

do not affect the FIIs activity in NSE. Remaining parameters do affect the FIIs activity in NSE, though not greatly.

• Moreover, we can’t statistically differentiate between M1 and M2 in terms of impact on the FIIs activity in NSE.

Recommendations

• FIIs should base their decision to invest in a specific market after doing comparative study of all prospective markets.

• Variables used to study emerging markets– MGR: Market Growth Rate– MI: Market Intensity– MCC: Market Consumption Capacity– CI: Commercial Infrastructure– EF: Economic Freedom– MR: Market Receptivity

Recommendations

• Regression output

Recommendations

• Interpretations– Adj. R2 = 0.9975 explanatory power is very high.– F-Statistic = 455 The regression model is quite

significant

• Drawbacks– Population size , n = 10 is very low (lack of availability

of quality data)

• If sufficient data is available then this model can be used finding the relationship between flow of FII’s and other parameters.

Bibliography

• http://www.equitymaster.com/india-markets/fiis/

• http://niftylivecharts.com/FII_activity.html• http://www.federalreserve.gov/releases/h3/

current/h3.htm• www.commerce.nic.in• www.rbi.org