Buoyed up by the recent indications of a stock market recovery, Foreign Institutional Investors (FIIs) have been switching their investments from the less beneficial debt market to the more lucrative equity market.

Since the beginning of the year, up to May 15, FIIs have withdrawn Rs3,962 crore debt investment, of which 93 per cent, or Rs3697 crore, was during the last one week, as indicated by the stock exchange data.

India's debt market includes government and corporate securities, and commercial paper. FIIs normally invest their funds for shorter periods in debt instruments and move to equities when the market starts to rise, with the prospects of higher returns.

Cost of funds for the FIIs is based on London Inter-Bank Offered Rate (Libor), which is 1.80 per cent at present, with an additional forward premium of 3 per cent on account of weaker rupee compared to the dollar.

A typical Indian debt security traded at 8.50 per cent would make a price differential of around 3.70 per cent which would be attractive to the FIIs when the stock markets perform weak as it happened in 2008. Even a 6 per cent 5-year government bond would fetch a differential return of 1.20 per cent.

Provisional data released by the stock exchanges for Tuesday showed a figure of Rs12,405.89 crore against FII purchases and Rs7,613.33 crore of sales, resulting in a net buy of Rs4,792.56 crore on both BSE and NSE.

On Monday's euphoria, when the equity markets shot up a record 2110 points in the benchmark BSE Sensex,  a whopping 17 plus per cent increase in less than a minute of trade, hitting the upper circuit breaker, the FIIs  made net purchases of Rs44.64 crore. Their gross purchases amounted to Rs56.91 crore against the sales of Rs12.27 crore.

On the contrary, Domestic Institutional Investors (DII) which include banks, financial institutions, insurance and mutual funds turned net sellers on both Monday and Tuesday. They sold shares worth Rs4623.16 crore yesterday and bought stocks worth Rs2658.97 crore resulting in net sale of Rs1964.19 crore.

On Monday DIIs were net sellers of Rs8.41 crore. They bought stocks worth Rs41.62 crore and sold equity worth Rs50.03 crore.

In other categories of investors, brokers on behalf of their clients and non-resident Indians were net sellers on Monday as well as Tuesday, whereas proprietary investors were net buyers.

Analysts point out that interest rates have fallen in April compared to March and to take advantage of the gaining stock markets, FIIs switch from debt to equity aiming at higher overall returns.

In a measure to attract more foreign investment, The Securities and Exchange Board of India (SEBI) in January 2009 raised the FII debt investment limits to $6 billion (Rs286 crore) in government bonds and $15 billion (Rs715 crore) in corporate papers.