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AN ASSESSMENT OF THE ROLE OF INTEREST RATE IN ENHANCING INVESTMENT IN DEVELOPING COUNTRIES: THE NIGERIAN EXPERIENCE (1981-2005)




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AN ASSESSMENT OF THE ROLE OF INTEREST RATE IN ENHANCING INVESTMENT IN DEVELOPING COUNTRIES:
THE NIGERIAN EXPERIENCE (1981-2005)






















ABSTRACT
        This work examines the role of interest rate in enhancing investment in Nigeria from 1980-2004. In carrying out the study we employ and econometric data analysis techniques of multiple regressions to text the relationship between interest rate, real income and investment. Our result reveals that interest rate is negatively related to investment while real GDP was positively linked to investment. The low level of investment and economic growth in Nigeria make it imperative to involve a policies that will enhance favourable interest rate and income level that will encourage investors to borrow money to invest in the economy. The study therefore, recommends a reduction of interest rate, upward review of personal income diversification of the productive base of the economy among others.
















TABLE OF CONTENTS
PAGE
Title page                                                                         i
Certification                                                                     ii
Dedication                                                                       iii
Acknowledgment                                                             iv
Abstract                                                                           vi
Table of content                                                               vii
List of table                                                                      x

CHAPTER ONE: INTRODUCTION
1.1   Background of the study                                          1
1.2   Statement of the problem                                        5
1.3   Objectives of the study                                             8
1.4   Research Hypothesis                                                       9
1.5   Scope and limitation of the study                            9
1.6   Significance  of the study                                         10
1.7   Organization of the study                                         10

CHAPTER TWO: LITERATURE REVIEW
2.0   Introduction                                                             12
2.1   Theories of interest rate determination                    12
2.2   Determinants of investment in Nigeria                     20
2.2.1 Interest rate structure                                             21
2.2.2 Exchange rate volatility                                          23
2.2.3 Investment capital                                                  26
2.2.4 High inflation                                                          29
2.2.5 Maturity structure of bank credit                            29
2.2.6 Incentives to encourage foreign private investment   30
2.2.7 Inadequate infrastructural facilities                                34
2.2.8        Debt overhang and debt service burden                  35
2.2.9 Inadequate legal framework                                    36
2.2.10 Complex regulatory framework                             37
2.2.11 Corruption                                                            39
2.3   Interest rate and investment                                    39

CHAPTER THREE: METHOD OF STUDY
3.1   Introduction                                                             46
3.2   Research design                                                       46
3.3   Data required                                                           46
3.4   Data collection method                                            46
3.5   Method of data analysis                                           47
3.6   Model specification                                                  48

CHAPTER FOUR: DATA PRESENTATION AND ANALYSIS
4.1   Introduction                                                             49
4.2   Data presentation                                                    49
4.3   Data analysis                                                           51
4.4   Interpretation of regression result                            52
4.5   Finding and implications of our regression result     53

CHAPTER FIVE: SUMMARY, RECOMMENDATION AND CONCLUSION
5.1   Summary                                                                         55
5.2   Recommendations                                                   56
5.3   Conclusion                                                              58
        Reference                                                                         60


















LIST OF TABLE
PAGE
Table 4.1: Investment, interest rate, and real GDP in
                 Nigeria 1980-2004                                          50
Table 4.2: Regression Result                                            51




















CHAPTER ONE
INTRODUCTION
1.1   BACKGROUND OF THE STUDY
        Interest rate is one of the most critical and controversial of all monetary and financial policies of developing economies. The policy is critical because, any interest rate policy has a direct effect on series of marco-economic variables which go beyond the monetary sector. It is controversial because the debate on the appropriate level and direction of interest rates in developing countries is largely unresolved (MCKINNON 1973; Shaw 1973, and Ogiogio 1989).
        While some analyst perceive the interest rate as the cost of investment which should be kept low to encourage investment in developing countries, others regard it as basically the cost of capital which is in short supply in these countries. According, proponents of the later view argue that interest rate should be kept higher in Developing countries than developed ones. However, which ever view one holds there is no gain saying the fact that interest rate policy of any economy is very crucial to it’s development primarily because of the effect of the policy on savings/investment and through the financial intermediation role of the banking sector.
        From the Lender’s point of view, interest rate is the reward for saving now and spending later. Thus, of primary concern to Lenders deciding how much to save and what financial assets to acquire, is the purchasing power of the funds returned when the financial asset are sold or returned later (Lombra,1984). This underlines the concept of the real interest rate in which the normal interest rate demanded by the Lender is viewed as being made up of two components. An inflation rate component which is perceived as a premium for saving now and paying later by the lender and secondly, a real interest rate component. Thus, savings assumed to be positively related to the real interest rate and investment at a given rate of economic growth. Proponents of this thesis, recommend that policy endavour to ensure lower real interest rate and expansion of the financial net work (Bhatia and Khatkhate, 1975). Anything short of this, like the policy of administrative control of interest rate and credit, will hold the real interest rate below its equilibrium level and thus leads to financial repression.
        The role interest rate play in determining investment and, hence economic growth, has been a matter of controversy over a long period of time. Yet, what constitutes an appropriate interest rate policy still remains to be a puzzling question. Until the early 1970’s, the main line of argument was that because the interest rate represents the cost of capital, low interest rate will encourage the acquisition of physical capital (investment) and promotes economic growth. Thus, during this era, the policy of low real interest rate was adopted by many countries including the developing countries of Africa. This position was however, challenged by what is now known as the orthodox financial liberalization theory. The orthodox approach to financial liberalization (Mckinnon-Kapar and the broader Mckinnon-Shaw hypothesis) suggests that high positive real, interest rates will encourage saving and later investment and growth in the long run, on the classical assumption that saving is necessary for investment, the orthodox approach brought into focus not only the relationship between investment and real interest rate, but also the relationship between the real interest rate and saving. It is argued that financial repression which is often associated. With negative real deposit rates leads to the withdrawal of funds from the banking sector. The reduction in credit availability, it is argued, would reduce actual investment and hinder growth. Because of this complementarily between savings and investment, the basic teaching of the orthodox approach is to free deposit rates-positive real interest rates will encourage saving; and the increased liabilities of the banking sectors will oblige financial institution to lend more resources for productive investment in a more efficient way. Higher loan rates, which follow higher deposits rates, will also discourage investment in low-yielding projects and raise the productivity of investment. This orthodox view became highly influential in the design of IMF-World Bank Financial liberalization programmes which were implemented by many Africa countries including Nigeria, under the umbrella or Structural Adjustment Programme. In this study there we seek to assess the extent interest rate has gone in stimulating or effecting the level of investment in Nigeria.

1.2   STATEMENT OF THE PROBLEM
        Since independence in 1960 Nigeria has been struggling to achieve a sustainable economic growth and development. The country has consistently witnessed low rate of growth and per capital income. One of the factors that accounted for this poor economic growth and performance is the low level investment.
        Prior to the present period privatization the bulk of investment in Nigeria was done by the public (government). Investment by the public was over 70%. While the private sector has the rest. As a result of the relinquishing of the productive sector to the private individual (privatization) the private sector is yet to take over the bulk of investment in the economy even when government had withdrawn.
        In reaction to the above scenario, the Nigerian government with the aid of the IMF adopted a comprehensive programme of economic reform known as the Structural Adjustment Programme (SAP) in 1086. Prior to this period, especially in the first half of 1980’s the Nigeria economy was in severe crisis arising from the defective structure of the economy, falling prices of crude oil in the international market, huge external dept stack and low level of investment.
        The main aim of the economic reform process was therefore, to restructure the production and consumption patterns of the economy, through the elimination of price distortion and reduction of the economy, on crude oil export and import of raw material and consumer goods. Thus the adoption of relevant pricing policies in all economic sectors with greater reliance on market forces and consequently reduction in complex administrative control became one of the three basic policy instruments of the adjustment programme (Uwatt, 1999).
        While the reform programme touched all sectors of the economy, the financial sector reforms aimed at removing the pervasive distortions introduced into the system through prolonged use of direct controls and excessive government intervention and improving the efficiency of the financial resources for economic development (Oke, 1995) one major sources of distortion in the financial resources of distortion in the financial sector was regulated interest rate. Beginning from March 1970 up to December 1986, interest rate was institutionally determined and administered in Nigeria. The Central Bank of Nigeria (CBN) was charged with this responsibility and throughout the period interest rates were fixed at very low level to promote investment and growth in the private sector and to keep interest payment on public sector borrowing as low as possible. Unfortunately this became a bane to funds mobilization through personal savings.
        However, the posture of government to deregulate the economy in order to enhance competition and investment necessitated the introduction of interest rate, based on market forces with effect from august 1987. The general argument therefore is that interest rates in Nigeria have been high and unrealistic to enhance the required level of investment and economic growth.
        Though some marginal improvements have been recorded in the country since the inception of the present administration due to its pressure on financial institutions to reduce interest rates in order to stimulate investment and economic growth, we are not sure that such improvement is captured by government effort. Therefore there is the need to critically examine the role of interest rate in enhancing investment in Nigeria. This is what has promoted this study. 



1.3   OBJECTIVES OF THE STUDY
        This study has its main objective to examine the impact of real interest rate on the level of domestic investment in Nigeria from 1981-2005. In specific terms, the study has the following objectives:
i.      To find out the interest rates obtainable in Nigeria from 1981-       2005.
ii.     To determine the level of investment in Nigeria from 1981-     2005.
iii.    To examine the impact of real interest rate on the level of       investment in Nigeria from 1981-2005.

1.4   RESEAERCH HYPOTHESIS
        This study was guided by the following hypothesis
H0: ao=O: There is no significant relationship between real interest        rate and the level of domestic investment in Nigeria from       1981-2005.
Hi: ao = O: There is a significant relationship between real interest         rate and the level of domestic investment in Nigeria from       1981-2005.

1.5   SCOPE AND LIMITATION OF THE STUDY
        This study is concerned with real interest rates with emphasis on the implications on domestic investment in Nigeria from 1981-2005. Prior 1986 represents the regulated era with government determining the cost of funds which was investment friendly due to low interest rates. The 1981-2005 period represents the liberalization period with market mechanism determining cost of funds. Thus, these time frames, the economic scenarios and there implications on interest rates and investments serve as limitations for this study.


1.6   SIGNIFICANCE OF THE STUDY
        The result of this study will provide a director for policy makers on the role interest rate play in fund mobilization and investment in Nigeria. It will also assist policy makers on designing economic policies aimed at mobilizing domestic resources for investment.
        The study also provide a window for financial institutions on strategies for fund mobilization and allocations (financial intermediation) in order to improve their performance in particular and that of the economy at large. Finally a study of this type will add to literature in monetary economics and serves as basic for further studies.
1.7   ORGANIZATION OF THE STUDY
        This is organized into five chapters. We begin by X-raying the interest rate and the level of investment in Nigeria, followed by the statement of problem, objectives of the study, research hypothesis, significance of the study, scope and limitation of the study and organization of study. Chapter two covers the review of relevant/related literature. Here emphasis is placed on findings of other scholars as a basis for establishing the points of departure of this investigation. The procedure followed in carrying out this investigation  i.e the research design, type of data required, sources of data, method of data analysis and model specification are contained in chapter three. Chapter four centres on the presentation of data analysis of data and interpretation of results and major findings, finally chapter five provides the summary, conclusion and recommendations for the study.









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