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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