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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