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EFFECTS OF INTEREST
RATES ON SAVINGS AND INVESTMENT IN THE NIGERIAN ECONOMY
CHAPTER ONE
INTRODUCTION
1.1
BACKGROUND TO STUDY
In Nigeria, interest
rate policy is among the emerging issue in current economic policy as regard
the role of it is expected to play in the deregulated economy in inducing
savings which can be channeled to investment and thereby increasing employment,
output and efficient financial resources utilization. The administration of low
interest rate which was intended to encourage investment was witnessed in the
1950s to mid 1960s.
In the third quarter
(3/4) of 1986, Structural Adjustment Programme (SAP) was
introduced by the then head of state General (Rtd) Ibrahim Gbadamosi Badangida.
This programme ushered in an era when fixed low interest rate was gradually
replaced by a deregulated interest rate regime where rates were more influenced
or determined by market forces. The policy shift de-emphasized direct
investment stimulation through the low interest rates. The mobilized fund was
intended for investment.
In Nigeria, the
pursuit of the two interest rate regime provide a case study for Keynesian
interest rate investment relationship and the McKinnon Shaw interest rate
saving and investment hypothesis. Several reason have been given as to why
people invest and save. Some of these reasons are; the direction of interest
rate, the returns that is expected from such an investment, the interest
accrues to savers and some other developmental reasons. It is obvious that the
higher the rate of interest the lower the level of investment and also the
lower the rate of interest, the higher the level investment.
However, this work is
also directed toward understanding the kind of relationship that exist between
interest rate, savings and investment McKinnon and Shaw conclude that higher
interest rate induce savings which can be utilized is investment therefore
these two transmission channeled through which interest rate affect investment,
the relate to interest rate as a cost of fund (capital).
Also, interest rate
encourage financial savings, which can be invested (self-finance) or lent out
to borrow as loan (external finance).
1.2
STATEMENT OF RESEARCH PROBLEM
The upsurge in real
interest rate observed worldwide in the early 1980’s raised a widespread
concern about their possible detrimental economic effects. Numerous studies
were carried out to measure the impact of high interest rates on key economic
variables such as growth of output, investment factor productivity and relative
factor returns in response to these concerns. An empirical regularity observed
in several cross-country studies e.g. World Bank (1989) and Galbis in 1992 that
countries with high real interest rate generally intended to exhibit faster
output growth but not higher investment, encourage a more efficient allocation
of resources which raises overall productivity such that the nit impact on growth
is positive while other studies e.g. (Khatkate 1998) have questioned the
empirical robustness of these findings. A basic lesson from this literature
skill hold namely higher interest rate on investment and growth mainly depends
on what has caused interest rate rise in the first place.
In Nigeria case, in
1986, interest rate was extensively prior to the adoption to SAP. The economic
rational behind this extensive control of interest rate and other elements of
financial market have been motivated by a variety of factors including the
desire to influence the flow of credit to preferred sectors of the economy and
the concern that market determined interest rate could result in a serious
imperfection in lending rate that would increase the rate cost of capital and
thereby discourage investment.
Moreover, such high
normal investment rate would also increase the cost of servicing the public
debt. Thus, interest rate policy should be used to increase the availability of
credit in order to encourage the accumulation of domestic financial assets by
offering holders of these asset sufficiently attractive rates. The deregulation
of interest rate during the SAP period seems to be justified by this
consideration.
The market determined
interest rate is meant to mobilize financial savings and for efficient
channeling of such savings into productive investment. This deregulation which
resulted to concurrent increase in interest rate and savings seem to lay
credence to McKinnon and Shaw interest rate, saving and investment hypothesis.
What happened to saving mobilized during this period is the key issue, which is
the focus of the study. The study will try to find out the following.
i.
Whether the savings generated during this period was transformed into real
investment.
ii.
What is the relationship between interest rate, savings and investment in
Nigeria?
1.3
OBJECTIVE OF THE STUDY
The objectives of the
study involves the following:
i.
To appraise the performance of interest rate policy in Nigeria in directly
stimulating investment on one hand and mobilizing financial solving on the
other hand by constructing an analytical model explaining the relationship
between interest rate, savings and investment.
ii.
To compare the effect of interest rate on savings and investment in an era of
strict interest rate administration and that of a liberalized interest rate
regime – specially the project will try to evaluate which of the two approaches
by the interest rate influences investment is more appropriate to Nigeria
iii.
To investigate using econometric analysis (technique) whether there is an
autonomous component in the investment pattern in Nigeria.
1.4
SIGNIFICANCE OF STUDY
Following the
downtime in Nigeria fortune arising from the collapse of world oil price in the
early 80’s, the economy has continued to wallow in uncertainties, manifesting
in several macroeconomic dislocation and internal and external disequilibrium.
This include price
instability, high rate of unemployment balance of payment problems, debt
crisis, political instability capital fight, low capacity utilization, low
savings, investment and income, downward trend in economic activities and
lately, economic depression. Several solution have been proffered to solve
these multifarious problems both by individual(s) and institutions prominent in
the later category is the Breton-Wood twice (IMF and World Bank) whose support
and influences fed to the adoption of Structural Adjustment Programme (SAP) by
the administration in 1986. The programme was to effectively after and
restructure the consumption and production pattern in Nigeria economy as well
as to eliminate price distortions and heavy producers goods. SAP is a programme
which combine a nexus of measure to promote economic efficiency and long term
growth with stabilization policies designed to restore balance of payment
equilibrium and price stability. The overall aim is to totally revering the
Nigeria economic (Anyanwu 1983). The fulcrum upon which the two key
macroeconomic variable (Savings and Investment rest is interest-rate).
Appropriate interest rate is the “sine qua-non” for saving mobilization and
transformation of such saving into profitable investment. Thus, this study will
be significant to policy makers to make appropriate policy which will go along
way toward alleviating investment problems and bring about the desired
improvement in the nation’s economy since developing economy like Nigeria which
is bedeviled by need to determine the appropriate policy mix to achieve
stability.
1.5
STATE OF HYPOTHESIS
In conjunction with
the objective state above. The following hypothesis will be tested to determine
the veracity of theories involved.
i.
Total financial savings has significant and negative relationship with the
level of investment.
ii.
Total financial saving has significant and direct relationship with normal
saving rate.
iii.
Total financial saving has a significant and positive relationship with the
level of investment.
iv.
Savings rates also depends on interest rate in Nigeria
v.
Inflation has an inverse relationship to both savings and investment.
1.6
RESEARCH METHODOLOGY
Efforts will be
intensifies toward reading textbook periodicals, seminar paper and some
economic journals in order to obtain require facts. Secondary data provide by
the Central Bank of Nigeria (CBN) and the Federal Office of Statistics (FOS)
will be used for regression analysis on the relevant using Ordinary Least
Square (OLS) method. The main benefit of the above methodology is that bias
from personal feeling is much reduced then would be found in primary data collection.
There can be
comparism as they are historically analysed based on past experience. Besides
those who write the periodicals and paper are authorized in their area of
specialization, this, what they say can be considered reliable. In the same
vein, simple regression analysis will be used to measure the co-variance
between interest-rate, savings and investment the main disadvantage is that not
all the required information can be provided by the date available for the
other weakness is that some of the data may not be up-to=date, but may be the
only available ones at the period of study.
1.7
DEFINITION OF TERMS
1.7.1
The meaning of interest rate
The rate of interest
is the reward of parting with liquidity for a special period. It is the inverse
proportion between a sum of money and what can be obtained for parting with
control overtime the money in exchange for a dust for a state period of time.
In this sense, it is
seen as a measure of the unwillingness of those who passes money to part with
their liquid control over it. It is the “prince” which equilibrate the desire
to hold wealth in the form of cash with the available quarterly of cash in the
price for credit (J.C. Anyanwu 1995).
1.
Minimum Discount Rate
This refers to the amount that is
charged by the Central Bank of Nigeria (CBN) for lending to banks in the
performances of its function of a lender of last resort. Minimum rediscount
rate also refers to charge by the Central Bank of Nigeria to the discounting
bills before maturity.
2.
Savings Deposit Rate
This rate is the amount paid by banks
for funds with withdrawal after seven day notice. Thus, restriction is however
soldomly applied.
3.
Fixed Deposit Rate
This is the rate paid when deposits are
fixed for a period of time say 90 or 180 days.
4.
Prime Lending Rate
This is the interest rate applied to
loans made to customers with the higher credit rating for each bank, the rate
should also represent the minimum rate.
5.
Maximum Lending Rate
This refers to amount charged by banks
for lending to customers with low credit rating.
6.
Inter Bank Interest Rate
This is the rate that applied to
transaction between banks mostly for over-night and short terms funds.
7.
Cost of Fund
This refers to net expense incurred in
raising borrowed fund including a reasonable profit margin. The expenses
include the interest on deposits, reserve requirement and other administrative
expenses as a proportion of total funds borrowed
8.
Treasury Bill Rate
This is the rate paid to holders to
federal government of Nigeria treasury bills issued by the Central Bank of
Nigeria (CBN). These bills have a maturity period of 90 days as opposed to
treasury certificates, which matures between one to three years.
9.
Rate of Return on Investment
This refers to the interest payable to
holders of government stocks, industrial stocks and equities (CBN).
1.7.2
What is interest rate policy
We can define
interest rate policy as one of the subset of policy measures enshrined in the general
set of monetary policy of the Central Bank.
i.
Aggregate Savings
It is the net
resultant of the savings of all individual units within the community.
ii.
Total Financial Savings
This is the sum of
saving and time deposit with Commercial, National provident fund Federal
Mortgage Banks, Time Deposit with Merchant Banks and premium bonds, savings,
certificate, saving stamps (CBN 1992).
iii.
Gross National Saving
This shows the amount
of domestic and foreign investment financial from output, comprising public and
private savings, Gross National/Savings (GSN). It is the residual of what is
not consumed from gross domestic income (CBN 1990).
1.7.3
What is Investment
Investment is the
addition to the existing stock real capital assets such as the purchase of
bonds, equities (stocks) construction of new factories new office building or
the acquisition of new capital assets like plants, equipment and machinery and
addition to inventions. Investment can also mean the deposit of saving in a
bank’s account (Iyoha 1996, Aigbokhn 1995).
i.
Gross Fixed Capital Formation
this measures the
total changes in value of fixed capital including stocks at current prices.
ii.
Security Investment
This refers to
investment on securities listed in the stock exchange such as equities,
government and industrial stock.
iii.
Foreign Private Investment
This provides a
pictures of the net inflow or outflow of foreign capital during a given period,
change in foreign share, trade and capital trade and capital transfer and
liabilities to head office such as capital transfer (CBN 1988 and 1990).
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