THE IMPACT OF INTEREST RATE POLICY ON INVESTMENT DECISION IN THE NIGERIAN ECONOMY (1990 – 2006)
- BACKGROUND OF THE STUDY
The financial system of most developing countries like Nigeria has come under stress as a result of the economic shocks of the 1980’s. Additionally, financial repressions largely manifested through indiscriminate interest rates has tended to reduce the real rate of growth and the real size of financial system with relative to the non-financial magnitudes. More importantly, financial repressions have retarded the developmental processes of the third world countries (Shaw 1973). Undoubtedly, government’s past efforts to promote economic development in Nigeria by controlling interest rates in other to secure fund at lower cost for funding governmental activities have undermined financial development of the Nigerian Economy.
Consequently, most countries both developed and developing ones have taken steps to liberalize their interest rates as part of their reforms of their financial system. Example of such reforms in Nigeria is the deregulation policy of 1986 which was one of the cardinal reforms in the financial system brought about by the Structural Adjustment Programmes (SAP). This reform aimed at a situation where the forces of demand and supply of fund in the financial market will determine the rates of interest with little regulation by the government. According to Killick and Martin (1990), such liberalization represents a policy response, encompassing a package of measures to remove all the undesirable imposed constraints on the free working of the financial market and the measures include the removal of interest rate ceiling and loosening of deposit and credit controls.
The financial sector of the Nigerian economy witnessed financial repression in the early 1980s, meaning that, as at that period, our financial system was weak. Then, there was rigid exchange and interest rates control which resulted to low direct investment and economic growth. Monetary and credit aggregates moved rather sluggishly, consequently there was a persistent pressure on the financial sector, which in turn necessitated a liberalization of the financial system brought about by the Structural Adjustment Programmes (SAP) financial reforms.
Nigeria has made efforts to attain economic growth and development by embarking on various economic policies at encouraging and promoting investment. Such policies include, protection of infant industries, liberal credit facilities for industrial and agricultural investment and interest rate policy among others (Udabah, 1999). There measures were pursued in appreciation of the role investment plays in the economic growth and development of any nation. Investment demand itself is influenced by several factors. These include the degree of risk associated with the venture, availability of retained earnings, inflation rate, the state of the economy, future speculations of the economic environment, exchange rate and of course the rate of interest at which investors can borrow money from banks and other financial institutions. From our a priori knowledge, of all these factors, rates of interest is the major determinant of investment demand and most theories of interest rate posited an inverse relationship between demand and the rates of interest. In otherwords, ceteris paribus, the lower the rate of interest, the higher the rate of investment demand vice versa, Dornbusch, Fischer and Startz (2004;245).
To this end, Evans (1999) examined and summarized the result of his finding in this area of research that the rate of interest is an important factor in determining the level of investment spending and capital function. According to him, a reduction change in the rate of interest, say from five to four percent (5%-4%) on the long run will cause a change in the level of net investment from five to ten percent (5%-10%).
Confirming this relationship, Okafor (1983) argued that the prevailing rate of interest determines the cost of capital for different firms and consequently, changes in the rates of interest determines the cost of capital for different firms and changes in the rate of interest have a great impact on investment behaviour. Therefore, if the rate of interest is high, funds will be expensive and difficult to come by and thus, period of tight monetary policy leads to slump in investment demand (activities). It therefore follows that for interest rates to stimulate investment demand its policy must be regulated within the acceptable standard that can accelerate the wheels of economic growth and development.
- STATEMENT OF THE PROBLEM
Being aware of the importance of investment in economic development, several attempts have been made by the government to promote the growth of investment demand in Nigeria. One of such attempts is the deregulation policy in the financial system, which aimed at reforming the interest rate policy. Despite all these policies geared towards promoting investment in Nigeria, it seems like the growth in investment is still low, therefore one cannot help but to ask what the problem is with the investment demand in Nigeria.
There is therefore a general perception that the inactiveness of these policies to boast up investment demand in the Nigerian economy arises from the fact that those policies are not well implemented. This therefore necessitates series of questions as to why is this situation in the Nigerian economy. Again, would positive implementations of interest rate policies facilitate the growth of investment in Nigeria for economic growth and development?
1.3 OBJECTIVE OF THE STUDY
The aim of this research work is to verify and ascertain the impact of interest rates on investment demand in the Nigerian economy with the aim of suggesting corrective measures which would be useful not only as a reference work to other students who may embark on a related research but also to proffer useful suggestions to our national economic planners for rapid economic growth and development.
Specifically, the core objectives of the study include:
- To identify the role of interest rate policy in Nigeria in encouraging investment.
- To identify the problems of interest rate policy in Nigeria.
1.4 Justification of the Study
The significance of this study should not be over-emphasized owing to the fact that more researches are needed to find out the most important economic and structural problems facing the Nigerian economy, particularly in the area/aspect of investment. Hence this study’s justification arises from the fact that it will contribute an additional knowledge to the existing ones on this area of study.
Also the study is carried out on the premise that those involved in formulating, directing and implementing macroeconomic policies especially monetary policies in controlling interest rates would take a cue from this study in the discharging of their duties. Investors are also considered to benefit in terms of serving as a guide to taking investment decisions.
1.5 STATEMENT OF HYPOTHESIS
The following hypotheses, which are subject to econometric and statistical tests, are formulated to guide the study.
- Lending rates of commercial banks within the period under study do not significantly influence investment demand in Nigeria.
- Savings deposit rates do not significantly influence investment in Nigeria.
- Central Bank Rediscount rate does not significantly influence investment in Nigeria.
Regression model is to be formulated and the least squares estimation (OLS) technique used to obtain the result.
Data will be obtained on various interest rates and Gross Capital Formulation a proxy variable for investment for the periods under study.
- SCOPE AND LIMITATION OF THE STUDY
The study is focused on the analysis of the interest rate policy and investment demand in Nigeria between 1990 and 2006 fiscal years.
Carrying out this research work alongside with other academics works constituted a limitation to the study. Also delay in accessibility of data from NBS, CBN and other resource rooms especially when in dare need of it is another constraint to the work.
- ORGANISATION OF THE STUDY
The study is organized into five chapters. Chapter one serves as the introduction /overview of the study.
Chapter two captures the view of the related literature while chapter three shows the research methodology adopted and the model specification.