The impact of interest rate on investment decision in nigeria. an econometric analysis (1981-2010)

Thesis Overview

<p> INTRODUCTION<br>1.1 Background of the Study<br>Investment is the change in capital stock during a period. Consequently, unlike<br>capital, investment is a flow term and not a stock term. This means that capital is<br>measured at a point in time, while investment can only be measure over a period<br>of time.<br>Investment plays a very important and positive role for progress and prosperity of<br>any country. Many countries rely on investment to solve their economic problem<br>such as poverty, unemployment etc (Muhammad Haron and Mohammed Nasr<br>(2004).<br>Interest rate on the other hand is the price paid for the use of money. It is the<br>opportunity cost of borrowing money from a lender to finance investment project.<br>It can also be seen as the return being paid to the provider of financial resources,<br>for going the fund for future consumption. Interest rates are normally expressed<br>as a percentage rate. The volatile nature of interest is determined by many<br>factors, which include taxes, risk of investment, inflationary expectations, liquidity<br>preference, market imperfections in an economy etc.<br>Banks are given the primary responsibility of financial intermediation in order to<br>make fund available for economic agents. Banks as financial intermediaries<br>move fund. Surplus sector/units of the economy to deficit sector/units by<br>accepting deposits and channeling them into lending activities. The extent to<br>which this could be done depend upon the rate of interest and level of<br>development of financial sector as well as the saving habit of the people in the<br>country.<br>Hence, the availability of investible funds is therefore regarded as a necessary<br>starting part for all investment in the economy which will eventually translate to<br>economic growth and development (Uremadu, 2006).<br>Many researchers have done a lot of study on the impact of interest rate on<br>investment. In Nigeria, Ologu (1992) in a study of “The Impart of CBN Money<br>Policy on aggregate investment behavior”. Found out only few of the variables<br>were significant at both the 95% and 90% confidence limits in explaining the<br>behavior of investment during the (1976-90) period of student”. Specifically, he<br>found out that:<br>1. Contrary to expectation and to change’s stock adjustment hypothesis, the<br>existing stock of capital goods (plants and machinery) was not a major<br>determinant of investment behavior of forms in Nigeria.<br>2. Interest rate was significant in influencing investment decision nothing<br>that” this is not surprising since in a situation of limited residual funds as in<br>Nigeria, the cost of capital should exert significant influence on both the<br>frequency and volume of demand for invisibles funds by investors.<br>Lesotho (2006) studied “An investigation of the determinants of private<br>investment “the case of Botwana”. Among his independent variable were real<br>interest rate, credit to the private investors, public investment and trade credit to<br>the private investors, real interest rate affect private investment positively and<br>significantly. Other variable do not affect private investment level in the shortterm<br>as they show insignificant co-efficient. GDP growth and conform similar<br>finding sin studies by Oshikoya (1994), Ghura and Godwin (2000) and Malmbo<br>and Oshikoya (2001).<br>Aysam et al (2004) in their study “How to Boot Private Investment in the MENA<br>countries. The role of Economic Reforms”. Among their independent variables<br>were accelerator, real interest rate, macroeconomic stability, structural reform,<br>external stability, macroeconomic volatility, physical infrastructure. Their studies<br>ranged from 1990 to 1990 comprising of panel of 40 developing countries. They<br>used co-integration technique to determine the existence of a long-term<br>relationship between private investment and its determinants. They fund out that<br>almost all the explanatory variables exhibit a significant impact on private<br>investment, with the exception of macroeconomic stability and infrastructures.<br>The accelerator variable (ACC) has the expected positive sign, which implies that<br>the anticipation of economic growth induce more investment. Similarly, interest<br>rate (r) appears to exert a negative effect on firm’s investment projects, which is<br>consistent with the user cost of capital theory.<br>In the U.S, Evans, estimated that net investment would rise by anything between<br>5% and 10% for a 25% fall in interest rate. These percentage changes were<br>calculated to occur over a two year period after a one year log.<br>A study by Kham and Reinhart (1990) observe that there is a close connection<br>between the level of investment and economic growth. In other words, a country<br>with low level of investment would have a low GDP growth rate. The use of ryid<br>exchange rate and interest rate controls in Nigeria in low direct investment, the<br>leads to financial impressions in the early 1980. Fund were inadequate as there<br>was a general lull in turn leads to the liberalization of the financial system Omole<br>and Falokun (1999). This may have an adverse effect on investment and<br>economic growth.<br>As already discussed so far, it is quite clear that an understanding of the nature<br>of interest rate behavior is critical and crucial in designing policies to promote<br>savings, investment and growth. It is pertinent to note that this research attempts<br>to investigate and ascertain the impact of interest rate volatility on investment<br>decisions in Nigeria using time series data covering from 1981-2010.<br>1.2 Statement of the Problem<br>The financial systems of most developing countries (like Nigeria) have came<br>under stress as a result of the economic shocks of the 1980s. The financial<br>repression, largely manifested through indiscriminate distortions of financial<br>prices including interest rates, has tended to reduce the real rate of growth and<br>the real size of financial system, more importantly, financial repression has<br>(retarded) delay development process as envisage by Shaw (1973). This led to<br>insufficient availability of investible funds, which is regarded as a necessary<br>starting point for all investment in an economy. This declines in investment as a<br>result of decline in the external resource transfer since 1982, has been especially<br>sharp in the highly indepted countries, and has been accompanied by a<br>slowdown in growth in all LDCs. Both public and private investment rate have<br>fallen, although the latter more drastically than the former. If this trend is<br>maintained, it will lead to a slowdown in medium term growth possibilities in<br>these economies and will reduce the level of long-term per capital consumption<br>and income, endangering the sustainability of the adjustment effort. The<br>observed reduction in investment in LDCS seems to be the result of several<br>factors. First, the lower availability of foreign savings has not been matched by a<br>corresponding increase in domestic savings. Secondly, the determinating of<br>fiscal conditions due to the cut of foreign lending, to the rise in domestic interest<br>rate, and the acceleration in inflation forced a contraction in public investment.<br>Thirdly, the increase in macroeconomic instability associated with external<br>shocks and the difficulties of domestic government to stabilize the economic has<br>hampered private investment.<br>Finally, the debt overhand has discourage investment, through its implied credit<br>constraints in international capital markets Luis Serven and Falokun (1989). <br></p>