Impact of interest rate on investment in Nigeria

 CHAPTER ONE

INTRODUCTION

  • Background of the study

Interest rate is the price paid for the use of money. It is the opportunity cost of borrowing money from a lender to finance investment project (Udabah, 2001). It can also be seen as the return being paid to the provider of financial resources, for going the fund for future consumption. Interest rates are normally expressed as a percentage rate. The volatile nature of interest is determined by many factors, which include taxes, risk of investment, inflationary expectations, liquidity preference, market imperfections in an economy etc.

Investment on the other hand plays a very important and positive role for progress and prosperity of any country. Many countries rely on investment to solve their economic problem such as poverty, unemployment etc (Muhammad Haron and Mohammed Nasr (2004). Banks are given the primary responsibility of financial intermediation in order to make fund available for economic agents. Banks as financial intermediaries move fund. Surplus sector/units of the economy to deficit sector/units byaccepting deposits and channeling them into lending activities. The extent to which this could be done depend upon the rate of interest and level of development of financial sector as well as the saving habit of the people in the country. Hence, the availability of investible funds is therefore regarded as a necessary starting part for all investment in the economy which will eventually translate to economic growth and development (Uremadu, 2006).

The interest rate policy in Nigeria is perhaps one of the most controversial of all financial policies. The reason is because interest rate policy has direct bearing on many other economic variables such as agriculture, exchange rate, GDP etc. Interest rate plays a crucial role in the efficient allocation of resources aimed at facilitating growth and development of an economy and as a demand management technique for achieving both internal and external balance.  The focus on the agricultural sector is centered on the ability of the sector in raw materials production for industries and food for consumption.

Apart from the above, it serves as a source of foreign exchange for the economy. Interest rates can have a substantial influence on Agriculture and pattern of economic growth. Changes in interest rates directly affect profitability of the agricultural sector by influencing borrowing, spending and investing, since agriculture is an especially capital-intensive industry. Changing interest rates indirectly also impact agriculture through affecting the level of general economic activity, such as output and employment, exchange rates and international trade. In developing economies, the agricultural sector is one of the most heavily regulated among others sectors like; oil, electricity and communication sector to mention a few.

Over and above all, the role of banks as financial intermediaries cannot be overemphasized because banks assist in channeling funds from surplus economic regions to the deficit ones in order to facilitate business transaction and economic development at large. In the same vein, the agricultural sector also benefited from surplus fund gotten form the surplus spending in the economy. This view is also buttressed by Anyanwu (1997) that Commercial Banks tends to encourage savings which in turn induces investment because investment are made out of savings, the establishment of commercial banks mostly in rural areas makes savings possible hence economic development is accelerated. Banks are perhaps the most heavily regulated of all businesses due to the fact that they are providers of finance which is often viewed as the lubricant of the economy as observed by Cameroun et al. (1967).

 

Akiri and Adofu (2007) established that the real sector is not the only sector that is been widely regulated rather, other sectors like the banking, culture industries, oil industry etc. has also been regulated both in developed and underdeveloped countries of the world.

Prior to the introduction of Structural Adjustment Programmes (SAP) in Nigeria in 1986, the Nigerian financial sector was characterized by rigid exchange rate and interest rate controls, mandatory sectoral allocation of bank credit to the private sector, all of which engendered distortion and inefficiencies that results to low direct investment. Funds were inadequate, the Nigeria currency was overvalued and the monetary and credit aggregate moved rather sluggishly such that the economy was sort of engulfed with a general lull. The introduction of SAP led to some financial regulations like; interest rate, exchange rate and other deregulations according to Ogwuma and Ojo (1993).

However, as an instrument of monetary policy the central Bank of Nigeria CBN (2000) indirectly influenced the level and direction of change in interest rate movement through its invention rate on various money market assets especially the Minimum Rediscount Rate (MRR) as well as the stop rate of weekly tender for treasury bills.

The MRR as the nominal anchor of CBN’s interest rate policy continued to be used proactively in line with prevailing economic conditions while the rate of treasury bills is made market related and competitive with comparable money market instruments CBN (2006). Further, the MRR has undergone some fluctuations since 1987 to date as a result of the changes in the CBN policies which in turn have changed the overall economic conditions. In August 1987, was 15.0% and was reduced to 12.75% in December of 1987 with the objective of stimulating investment and growth in the economy. In 1989, the MRR was raised to 13.25% in order to contain inflation.

  • STATEMENT OF THE PROBLEM

One of the major objectives of monetary policy on interest rate in Nigeria is price stability so as to boost the investment in the economy. But despite the various monetary regimes that have been adopted by the Central Bank of Nigeria over the years, inflation still remains a major threat to Nigeria’s economy thereby lowering the investment levels. The Nigeria economy has encountered the problem of disequilibrium, inability to mobilize domestic savings and unsatisfactory expansion of domestic output. These problems have consistently and presently done severe damage to Nigeria economy; but most strikingly these problems have continued to play the economy unabated that is, the economy is becoming less strong. Ojo (2007) observed that, the Nigerian investment has evolved over the past 50 years. It has grown structurally and has had improved monetary policy role. The economic growth rate (real GDP growth rate) has also been volatile over the past years. The financial sector which had the Central Bank of Nigeria (CBN), a handful of commercial banks, insurance companies, a stock market in the1970s, now consist of the CBN, 24 deposit money banks, 5 discount houses, 840 micro finance banks, 5 development finance institutions, 1 stock exchange, 1 commodity exchange, 73 insurance companies, 80 primary mortgage institutions, 102 finance companies, and 1,264 bureau de change (CBN, 2008). Also, major financial ratios like M2/GDP, ratio of credit to private sector/GDP (CBN Private Investment indicators) and ratio of currency outside banks/M2 have shown some improvement over the years. Despite the growth experienced in the financial sector over the years, the Nigerian financial sector has been described as weak, fragmented, unable to provide domestic credit to the private sector and not in a position to effectively support a strong expansion of the real sector as well as contribute to economic growth. Previous researches have dealt separately with monetary policy as a whole and investment but not based on specifically on interest rate and investment. Based on this understanding, it is clear that there exists a gap in literature with regard to understanding the impact of interest rate on investment suggesting the need for research that will consider specifically on monetary policy instrument like interest and its impact on investment. This is accomplished by emphasizing the effects of monetary policy variables such as money supply and interest rate whilst estimating the long run relationship.

  • OBJECTIVE OF THE STUDY

The objectives of the study are;

  1. To determine the impact of interest rate on savings in Nigeria.
  2. To determine the impact of savings on Investment in Nigeria
  3. To determine how interest rate impact on the investment rate in Nigeria.
    • RESEARCH HYPOTHESES

For the successful completion of the study, the following research hypotheses were formulated by the researcher;

H0there is no impact of interest rate on savings in Nigeria.

H1: there is impact of interest rate on savings in Nigeria.

H02:   interest rate has no impact on the investment rate in Nigeria.

H2:   interest rate has impact on the investment rate in Nigeria.

  • SIGNIFICANCE OF THE STUDY

The deterioration of the Nigeria economy calls for a scrutinization of the economic policies. This Nigeria like all other developing countries is faced with the problem of choosing the most appropriate policies, which will be employed to attain economic growth. An identification of the factors, which influence the economy, becomes necessary, the level of investment being a major influence of economic growth lead us to the study of interest rate which is one of the factors influencing investment as well as savings (which provides funds for investment). In order to avoid decisional myopia there is a need for efficient and proper economic planning. The need for undertaking this study stems from the important role the rate of interest plays in determining the growth of savings and investment. This shall be of immense benefit to commercial banks in general, the CBN, the general economy and to future researchers in the field of interest rate.

  • SCOPE AND LIMITATION OF THE STUDY

The scope of the study covers Impact of interest rate on investment in Nigeria. The researcher encounters some constrain which limited the scope of the study;

  1. a) AVAILABILITY OF RESEARCH MATERIAL: The research material available to the researcher is insufficient, thereby limiting the study
  2. b) TIME: The time frame allocated to the study does not enhance wider coverage as the researcher has to combine other academic activities and examinations with the study.

1.7 DEFINITION OF TERMS

Interest Rate: This is the rate at which the Central Bank of Nigeria lends to financial institution thus supply and demand for funds Mwega, Ngola, and Mwangi, (1990)

Interest rate policy:This is the policy Central Bank uses to control inflation in the economy. It also used to control the money supply by the monetary authorities, in order to achieve the stated or desired goals Ndulu (1990).

Investments investible Funds which are utilized to expand the growth in the economy Elliot(1984).

 

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